Student loans are among the most common sources of debt in America. It has been reported that about one in five Americans have student loan debt-totaling more than $1.7 trillion.
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If you’re one of those people, you are probably waiting to hear whether—in these times of high tuition and inflation—some portion of your federal student loan will be forgiven or whether the federal government’s pause on student loan payments and interest will be extended. (Stay tuned: news on the student loan forgiveness front is expected soon from the Department of Education.
In the meantime, though, it may help to refresh your knowledge of some of the ways that having a federal student loan, can affect your taxes.
Student Loans Are Not Considered Income
A typical question surrounding student loan debt is whether a student loan is income for tax purposes. The fortunate answer is no, the IRS doesn’t consider student loans to be income.
Income that is taxable is usually made up of salary and wages. The IRS also considers unearned income (e.g., winnings or profits from sales of assets or stocks) to be taxable. So, because student loans are debts that are intended to be repaid with interest, they are not taxable income and do not need to be reported as such on your tax return.
You Can Sometimes Deduct Student Loan Interest
Additional good news about student loans and taxes is that you may be able to deduct the interest that you pay on your student loan on your tax return. That deduction can potentially save you a little money at tax time.
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Right now, due to pandemic relief, payments and interest on student loans are on pause until the end of August. However, normally, when you pay interest, the IRS allows you to deduct either the amount of interest you paid during a given tax year, or $2,500, whichever is less. And, you don’t have to itemize your deductions to claim student loan interest because the IRS considers student loan interest to be an adjustment to your income.
To claim the student loan interest deduction, you must have paid interest on what the IRS calls a “qualified student loan.” That is essentially a loan that was taken out to pay for higher education expenses for you, your spouse, or a dependent.
But whether you can claim a deduction for student loan interest also depends on several other factors including on your filing status and income. That’s partly because the student loan interest deduction phases out depending on the amount of your modified adjusted gross income.
For example, if you are married and want to claim the student loan interest deduction, you cannot file separately, and you and your spouse cannot be claimed as dependents on someone else’s tax returns. Also, your modified adjusted gross income must stay within a specified amount.
In 2022, if your modified adjusted gross income is less than $70,000 (if you’re single) or $145,000 (if you’re married filing jointly), you could deduct the amount you paid or $2,500, whichever is less. However, single filers whose modified adjusted gross income fell between $70,000 and $85,000 or married filers whose income fell between $145,000 and $175,000, would have their student loan interest deduction reduced. This is because their modified adjusted incomes are higher.
More information about the student loan interest deduction can be found on the IRS website.
Student Loan Forgiveness May or May Not be Taxable
While it’s important to know whether student loans are income and whether you can deduct student loan interest on your taxes, the question of the day is whether federal student loans will be forgiven soon. And if some portion of your student loan is forgiven, that will be good news—if, of course, the student loan forgiveness isn’t taxable to you.
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Whether you will be taxed on the amount of your federal student loan that is forgiven is complicated. This is partly because there are various types of student loan programs and repayment plans. And it’s unclear how a large-scale federal student loan forgiveness program would treat forgiven or cancelled debt for tax purposes.
Typically, the IRS treats cancelled and forgiven debt as taxable income. There are some exceptions to this that have applied recently to student loans, mainly because of legislation passed during the COVID-19 pandemic. For example, the American Rescue Plan Act (ARPA) paused taxes on student loan forgiveness from 2021 through 2025 for people whose student loans are classified under the Income-Driven Repayment program. ARPA also granted similar relief under other repayment programs.
Also, student loan borrowers whose loans were forgiven as part of the Public Service Loan Forgiveness program, are also currently exempt from tax on the forgiven amounts. (Eligibility for that program has also recently been expanded).
As a result, you will have to wait and see whether broad federal student loan forgiveness comes to fruition and if so, whether the amounts forgiven will be taxable.
Employer Repayment Assistance Could Be Taxable to You
In light of the pandemic in 2020, Congress passed the CARES Act, which contained provisions allowing employers to contribute money toward the federal or private student loans of their employees.
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Under CARES, employers could directly contribute $5,250 each year tax-free to employees’ student loans. This employer student loan repayment assistance has been extended through 2025.
If your employer offers this benefit, it’s currently a way to reduce your student loan debt that is tax-free to you. However, because it’s a form of debt forgiveness, it is unclear-whether after 2025, when the tax relief is set to expire, employer repayment assistance for your student loan will, or won’t, be taxable to you.
Defaulting on Your Student Loan Can Create Tax Problems
Data show that one-third of borrowers have already defaulted on their student loans—some more than once. But because of recent pandemic relief (mentioned previously) many borrowers who defaulted on their loans were able to have their good standing reinstated in the last couple of years. However, with current soaring inflation and looming recession, it’s hard to say whether that so called “fresh start” student loan relief will translate to fewer defaults.
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Before default relief was put in place, the penalties associated with student loan default could be significant and included things like high negatives on your credit rating and wage garnishment. Tax consequences for defaulting on your federal student loan were also hefty. For example, the federal government could seize your tax refunds and even some of the refundable portions of certain tax credits.
Even though student loan payments are currently paused, if you think that you might default on your federal student loan, reach out to the Department of Education or your loan servicer to find out about any available loan rehabilitation program.
Various Tax Forms Are Associated with Student Loans
When you have a student loan, the interest you pay on it is reported to you on Form 1098-E if you paid at least $600 in interest during the tax year. (But remember, you probably didn’t pay interest recently because of the pause on student loan interest and payments).
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Normally Form 1098-E is mailed to you, but you can also find a copy of your Form 1098-E on your loan servicer’s website or by contacting your loan servicer. You use the information provided on the form to claim the student loan interest deduction.
Another tax form that can be related to your student loans is Form 1098-T, which shows the amount of qualified tuition and related education expenses that you paid during the tax year. Form 1098-T can be useful in claiming education tax credits that might also help to reduce your tax bill.
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