Preparing and filing taxes is rarely fun, and every new form can complicate the process. Fortunately, while student loans can affect your tax return in several ways, the changes are generally straightforward and easy to understand.
Paying for school and repaying your loans could help you qualify for money-saving credits or deductions. On the other hand, having a loan forgiven or falling behind on your loan payments might lead to paying more in taxes or receiving a smaller refund.
Here are four situations when having a student loan could impact your taxes.
Paid for educational expenses? You may qualify for a tax credit
If you paid for educational expenses, such as a college or graduate school tuition or fees, you may be eligible for one of the two higher education tax credits.
A tax credit is generally more valuable than a tax deduction because credits will decrease how much you owe, or may increase your refund, on a dollar-for-dollar basis. By contrast, deductions decrease your taxable income. For example, a $500 tax credit could lower your taxes by $500, but a $500 tax deduction might only lower your taxes by $110 if you’re in the 22 percent tax bracket.
There are two higher education tax credits to look for, although you can only claim one of them each year.
- The American Opportunity Tax Credit. The American Opportunity Tax Credit is worth up to $2,500. However, you can only claim this credit during an eligible student’s first four years at a post-secondary school. The student also must be enrolled at least half-time.
- The Lifetime Learning Credit. The Lifetime Learning Credit is worth up to $2,000, and there’s no limit to how many times you can claim the credit. It could be a good option if it takes longer than four years to complete an undergraduate degree, or if you’re returning to school for a graduate degree or certification program.
The credit’s value is based on your qualified education expenses, and you can claim the credit even if you used money from a student loan to pay for the expenses. You can also claim the credit if you paid for eligible educational expenses for a spouse or dependent child who was a student.
There are some additional requirements and limits to the credits, but you can use the IRS’s interactive tool to quickly see if you qualify.
Repaying student loans? Don’t forget the interest deduction
If you’ve started repaying your student loans (even if you’re still in school), you may qualify for the student loan interest deduction. The deduction could lower your income by the amount of interest you paid during the year, with a maximum deduction of $2,500. You could save you hundreds of dollars on taxes as a result.
There are a few criteria you’ll need to meet to qualify:
- You paid interest on a qualified student loan, such as a federal student loan
- You were legally required to pay interest on the loan
- No one else can claim you (or your spouse if you file a joint return) as a dependent on their tax return
- If you’re married, you can’t file your tax return with the married filing separately status
There’s also a modified adjusted gross income (MAGI) limit that you must be below to qualify for the deduction. MAGI is your income minus certain deductions, meaning, it’s likely lower than your total income for the year.
If your MAGI is too high, you might not qualify, or you may qualify but with a lower deduction amount. For single taxpayers during the 2018 tax year, the deduction limit starts to decrease once your MAGI is $65,000, and you can’t claim the deduction at all once your MAGI is $80,000.
For those filing a joint return, the limits are $165,000 to be eligible and $135,000 for the full refund.
Was your student loan forgiven? You might pay more taxes
You may have been fortunate enough to have your student loans forgiven, but you might be surprised to find that the forgiven debt can actually lead to a large tax bill. This is because forgiven or cancelled debt (including non-student debt, such as a settled or discharged credit card balance) could be treated as income for the year.
There are federal, state, and employer-based student loan forgiveness or repayment assistance programs. Whether the forgiveness is treated as income depends on which program you used.
The forgiven amount is not taxable if your federal student loan is forgiven through one of the following programs:
- Public Service Loan Forgiveness (PSLF)
- Student Loan Forgiveness for Teachers
- Total and permanent disability (TPD) discharge
- Some student loan cancellation and repayment assistance programs that are offered to healthcare workers
With other forgiveness or repayment assistance program, the forgiven amount or assistance you receive may be taxable.
Behind on your student loans? Your refund could be at risk
You may be looking forward to getting a tax refund and catching up on some past-due bills. However, if you’ve defaulted on your federal student loans (i.e., are at least 270 days past due), your federal income tax refund could be taken and used to repay the loans.
If you fell behind on a student loan that’s part of the FFEL loan program, your state tax refund could also be taken. In some cases, a defaulted student loan might result in losing a state-issued license, such as your driver’s license or a professional license.
You should receive a mailed notice warning you that your tax refund will be taken. If you act quickly, you may be able to get your loan out of default and keep your entire refund. Some of the options, such as consolidating your federal student loans or applying for deferment, don’t cost any money. They could lower your monthly payments and make it easier to afford your payments going forward.
Student loans — an important piece of the tax puzzle
Whether you’re able to lower your tax bill by claiming tax breaks or wind up paying more due to having your loans forgiven, your student loans could have a major impact on your taxes this year. However, don’t file your tax return and forget all about it. Knowing how your loans might impact your finances in the future can also help you better manage your money and plan for filing taxes in the years to come.
Ready to learn more?
Understanding how student loans can impact your taxes can be especially important during tax season, but it’s a small part of overall student loan management. You can learn more about managing and repaying your student loans in the Pillar blog, and you can sign up for Pillar to receive personalized recommendations based on your finances and loans.