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4 Ways Student Loans Can Impact Your Taxes

Are you one of the millions of borrowers who are eagerly awaiting to see if Biden’s student loan forgiveness plan eventually goes through? Although it would be nice to have up to $10,000 (or $20,000 if you have Pell Grants) wiped clean with the stroke of a pen, the reality is that you’re more likely to get relief from one of the existing programs or an employer’s benefit plan. These programs, however, may have tax consequences. With the start of payments in limbo until a final decision is made regarding Biden’s cancelation plan, now is a good time to review how student loans can impact your taxes at the state and federal levels.

Student Loan Interest is Tax Deductible

Normally, you can deduct your student loan interest (up to $2,500) if you meet the eligibility requirements. This helps lower your adjusted gross income (AGI), which can also help you qualify for other federal tax deductions and credits. Interest paid on all federal student loans and most private student loans qualifies for the deduction. Currently, payments and interest on federal student loans are on pause due to the coronavirus pandemic. This temporary relief, however, will expire once the legal battles are resolved or by September 1, 2023, whichever happens first.

Taking The Deduction During Normal Tax Years

During normal tax years, you don’t need to itemize to take the interest deduction. The amount of the deduction is simply included on line 1 of Schedule 1 (Form 1040). You must, however, meet other criteria to be eligible for the interest deduction.

  1. Your filing status is not married filing separately.
  2. You must not be claimed as a dependent on another taxpayer’s return.
  3. You are legally obligated to pay the student loan.
  4. The student for which the loan was obtained must have been enrolled at least half-time in a program leading to a degree or certificate at an eligible post-secondary institution.
  5. You have a modified adjusted gross income that does not exceed the set limits.

For the 2022 tax year, the income thresholds are as follows:

Credit AmountSingle, Head of Household, or Qualifying Widow(er)Married Filing Jointly
Full Credit$70,0000 or less$140,000 or less
Partial CreditBetween $70,000 and $85,000Between $140,000 and $170,000
No CreditMore than $85,000More than $170,000
Source: Internal Revenue Service

If you don’t receive Form 1098-E, Student Loan Interest Statement, you can contact your student loan servicer or log into your online account to determine how much interest you have paid throughout the tax year. You can also use the worksheet in IRS Publication 970 to help you calculate the amount of your deduction.

Student Loan Forgiveness May Be Tax-Free

The IRS typically treats canceled and forgiven student loan debt as taxable income. Thanks to the American Rescue Plan Act and other COVID-19 relief, however, you likely won’t pay any federal taxes if your student loans are forgiven between 2021 and 2025. This includes Biden’s student loan cancelation plan if it’s allowed to move forward. Several programs, such as the Public Service Loan Forgiveness program and Borrowers Defense to Repayment program, have offered federal tax-free forgiveness for years.

Although you may not be taxed at the federal level, some states have indicated that they still plan to treat canceled or forgiven student loans as taxable income. Be sure to check with your state’s taxing authority or consult with a tax professional to determine what, if any, tax consequences there may be if your student loans are forgiven.

Employer Repayment Assistance Could Be Taxable

Even if you don’t qualify for student loan forgiveness, you may be able to get help paying off your loans through an employer repayment assistance program. A growing number of companies are adding this perk to their employee benefits packages.

Thanks to the CARES Act and the 2021 Consolidated Appropriations Act, your employer can now make up $5,250 in tax-free, direct payments annually to your federal student loans through 2025. Since the payments are tax-exempt, you won’t pay any federal income taxes and your employer won’t owe payroll taxes.

Just like student loan forgiveness, however, there may be some states that choose to tax this benefit. And, after 2025, there’s no guarantee that the IRS won’t consider these payments as taxable income again.    

Student Loan Default May Trigger a Tax Refund Offset

When the student loan repayment pause expires, collection efforts will likely resume. If your student loan is in default, this could put your tax refund in jeopardy.

The Treasury Offset Program (TOP) has the authority to collect past-due debts that are owed to state and federal agencies. This includes, but is not limited to, unpaid child support, back taxes, and defaulted student loans. If you default on your student loan, TOP can take your state and/or federal tax refund (this is known as tax refund offset) to pay down your overdue balance. Once your tax refund is seized, there is very little you can do to recover it.

Get Help Now

Not sure how student loan forgiveness or cancelation will impact your state or federal income taxes? Worried that you may lose your tax refund because you’re not prepared to make payments or your student loan was previously in default? Contact Tax Defense Network at 855-476-6920. We offer a 100% free, confidential consultation. Together, we’ll explore your options and put together a plan that minimizes your tax liability and protects your hard-earned money. Call us today!