Student loans are among the most common sources of debt in America. It has been reported that about one in five Americans has student loan debt — more than $1.7 trillion in total.
If you’re one of those people, you’re probably waiting to hear if — in these times of high tuition and inflation — some of your federal student loans will be forgiven, or if the federal government is suspending student loan payments and interest rates. (Stay tuned: news on student loan forgiveness is expected soon from the Department of Education.
In the meantime, however, it may be helpful to refresh your knowledge of some of the ways a government student loan can affect your taxes.
Student loans are not considered income
A typical question related to student loan debt is whether a student loan constitutes income for tax purposes. The happy answer is no, the IRS does not consider student loans as income.
Taxable income usually consists of wages and salaries. The IRS also considers unearned income (such as gains or gains from the sale of assets or stock) to be taxable. Because student loans are debts intended to be paid back 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
Another piece of good news about student loans and taxes is that you may be able to deduct the interest you pay on your student loan on your tax return. This deduction can potentially save you a little money at tax time.
Currently, due to pandemic relief, student loan payments and interest are suspended until the end of August. However, if you pay interest, the IRS typically allows you to deduct either the amount of interest you paid during a particular 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 as an adjustment to your income.
To qualify for the student loan interest deduction, you must have paid interest on what the IRS calls a “qualifying student loan.” This is essentially a loan taken out to help cover the cost of higher education for you, your spouse, or a loved one.
However, whether you can claim a student loan interest deduction also depends on several other factors, including your filing status and income. One of the reasons for this is that the interest deduction for the student loan expires 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 it 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 certain amount.
If your modified adjusted gross income in 2022 is less than $70,000 (if you’re single) or $145,000 (if you’re married together), you can deduct the amount you paid or $2,500, whichever is the case , whichever amount is lower. However, single applicants whose modified adjusted gross income fell between $70,000 and $85,000 or married applicants whose income fell between $145,000 and $175,000 would have their student loan interest deduction reduced. This is because their modified adjusted earnings are higher.
For more information on student loan interest deductions, visit the IRS website.
Student loan forgiveness may or may not be taxable
While it’s important to know if student loans are income and if you can deduct student loan interest from your taxes, the question of the day is whether federal student loans will be forgiven anytime soon. And if part of your student loan is forgiven, that will be good news – if, of course, the student loan is forgiven is not taxable for you.
Whether or not you will be taxed on the amount of your federal student loan forgiven is complicated. This is partly because there are different types of student loan programs and repayment schedules. And it’s unclear how a large-scale federal student loan forgiveness program would treat forgiven or forgiven debt for tax purposes.
Typically, the IRS treats canceled and forgiven debt as taxable income. There are some exceptions that have recently applied to student loans, mainly due to legislation passed during the COVID-19 pandemic. For example, the American Rescue Plan Act (ARPA) paused student loan forgiveness taxes from 2021 through 2025 for individuals whose student loans are covered under the income-based repayment program. ARPA also granted similar relief under other repayment programs.
Student loan borrowers whose loans have been forgiven under the government loan forgiveness program are also currently exempt from tax on the forgiven amounts. (The eligibility for this program was also recently expanded).
As a result, you’ll have to wait and see if student loan forgiveness becomes widespread and, if so, whether the amounts forgiven are taxable.
The employer’s repayment support could be taxable for you
In light of the 2020 pandemic, Congress passed the CARES Act, which included provisions allowing employers to contribute money to their employees’ state or private student loans.
Under CARES, employers could contribute $5,250 tax-free each year directly to employee student loans. This employer student loan repayment assistance has been extended to 2025.
If your employer offers this benefit, it’s currently a way to reduce your student loan debt that’s tax-free to you. Because it’s a form of debt relief, however, it’s unclear whether or not after 2025, when the tax break expires, you’ll be taxable on the employer loan repayment loan on your student loan.
Defaulting on your student loan can cause tax problems
The data shows that a third of borrowers have already defaulted on their student loans — some more than once. But with the recent easing of the pandemic (mentioned earlier), many borrowers who have defaulted on their loans have been able to regain their good reputations in recent years. However, with inflation soaring at the moment and a recession looming, it’s hard to say whether this so-called “reboot” student loan relief will result in fewer defaults.
Before default was introduced, the penalties associated with student loan default could be significant and included things like high negative impact on your credit score and garnished wages. Tax ramifications for not paying your federal student loan were also severe. For example, the federal government could seize your tax refunds and even some of the refundable portions of certain tax credits.
Although student loan payments are currently on hold, if you think you may default on your government student loan, contact the Department of Education or your loan servicer to learn about available loan rehabilitation programs.
Various forms of taxes are associated with student loans
If you have a student loan, the interest you pay on it will be reported to you on Form 1098-E if you paid at least $600 in interest during the tax year. (But keep in mind that you probably haven’t paid any interest lately because interest and student loan payments have been suspended).
Typically, a 1098-E form will be mailed to you, but you can also find a copy of your 1098-E form on your credit servicer’s website or by contacting your credit servicer. Use the information on the form to apply for student loan interest deduction.
Another tax form that may relate to your student loans is Form 1098-T, which shows the amount of qualifying tuition and related educational expenses you paid during the tax year. Form 1098-T can be helpful when applying for education tax credits, which can also help reduce your tax burden.