Many students borrow money or accept grants and scholarships to help pay for higher education. Fortunately, student loans are not taxable,…
Many students borrow money or accept grants and scholarships to help pay for higher education. Fortunately, student loans aren’t taxable, so you don’t report student loans as income on your tax return, and you don’t have to pay tax on certain types of financial aid.
Although loans do not count as income, settled student loan debt is generally taxable.
If the IRS considers money you received for school taxable income, it “has a direct impact on your taxes,” says Kristin Ingram, CPA, clinical instructor in accounting at the University of Hartford and owner of accounting education website Accounting in Focus. “The more taxable income you have, the higher your taxes will be.”
Taxable income is your total income after subtracting deductions and exemptions for the tax year.
If you use more than one way to pay for your education, you may not know what’s taxable and you’re worried about ending up with a big tax bill. Here’s what you need to know about how student loans can affect your taxes, as well as tax benefits that could reduce your burden.
[Read: Best Private Student Loans.]
Are student loans taxable?
Uncle Sam does not consider student loans to be taxable income, whether federal or private. But you may have to pay taxes on:
Portions of scholarships and grants. You will have to pay taxes on scholarships used for anything other than tuition, books, and supplies. If you received a $15,000 scholarship and spent $12,000 on tuition but the rest on room and board, then you would have to pay taxes on the $3,000 difference.
You will also receive a tax bill on payments you receive for teaching or research required for scholarships or grants.
Tuition assistance programs offered by the employer. Some employers reimburse tuition or pay off student loans to attract talent. The disadvantage of these programs is that the contributions made to employees may be taxable.
You will pay taxes on any amount over $5,250 for your education in a year, and your employer must report the taxable portion on your Form W-2.
Allowances for student-athletes. As with scholarships and grants, these allowances are taxed when used for room and board or incidentals.
Federal work-study programs. Whether you receive salary or hourly pay as an undergraduate or graduate student, your work-study earnings are taxable. Your school will give you a W-2 form with all the information you need to report your salary.
What type of financial assistance is not taxable?
You won’t have to pay tax on these types of school financial aid:
Student loans. Private and federal student loans are not taxable because they must be repaid, says Mark Misselbeck, CPA and tax practitioner at Katz, Nannis and Solomon PC.
“So you’re not ahead of the game: you have to pay the money back at some point,” he says.
Scholarships and grants used for certain expenses. The IRS maintains that you must be a degree-seeking student at a qualifying educational institution and that the amounts you receive must be used for books, supplies, tuition, and fees in order to exclude from your taxable income. You will have to pay taxes on the money you spend on room and board, travel and incidentals.
Room and Board of the Resident Advisor. Dorm Resident Advisors, or RAs, can have long hours and a bit of drama, but the job has its perks: traditionally, free room and board. Income tax generally does not apply to these benefits.
“It’s because college requires you to live there as a condition of your job, and it benefits your employer,” Ingram says.
College savings plans. Some types of accounts can grow tax-free to pay for eligible educational expenses. These include Series EE or Series I bonds issued after 1989, 529 college savings accounts and Coverdell college savings accounts.
If you have a 529 plan, you can also withdraw up to $10,000 from your account tax-free to pay off qualified student loans or apprenticeship program costs. But check the fine print: each type of account has its own rules for tax-free withdrawals.
[Read: Best Student Loan Consolidation and Refinance Companies.]
Is student loan forgiveness taxable?
Under the American Recovery Act, student loan debt that is forgiven or discharged is exempt from federal tax until 2025, including income-driven repayment plans. However, state taxes may apply.
If you don’t have to pay your loans based on your career choice, this is called a forgiveness or cancellation. Loans canceled under the Department of Education’s Civil Service Loan Forgiveness Program, for example, are not taxable. The program cancels the balance of your direct federal loans after you make 120 monthly payments under an eligible repayment plan while working full-time for an eligible employer.
On the other hand, release is when you no longer have to make payments due to circumstances such as total and permanent disability or when your school closes. If your federal student loan is canceled between January 1, 2018 and December 31, 2025, due to disability or death, it will not be considered taxable income. Unfortunately, the law is not retroactive.
If you pay off your federal or private student loan for less than the full amount, you may have to pay taxes on what you didn’t pay. Talk to a tax professional about your situation.
You’ll want to figure out how to pay the tax bill before settling student loan debt, Ingram says. An insolvency exemption, for example, might allow you to exclude settled debt from your gross income.
“Let’s say you pay $10,000 in taxes to cancel a $40,000 student loan,” she says. “It could totally make sense. But for most people who are able to get a student loan forgiven, they might not have the $10,000 to pay the taxes.
[Read: Best Student Loans Without a Co-Signer.]
Tax relief for student loans
Tax deductions and credits can help you recoup some of the money you spend on tuition and other higher education costs.
A deduction can reduce your taxable income, and a credit reduces your tax bill and can give you a refund.
Education credits include:
– American Opportunity Credit, which allows you to claim up to $2,500 per year for the first four years of study for a diploma or similar title.
– Lifetime Learning Credit, which allows you to claim up to $2,000 per year for college or vocational school tuition and fees, as well as necessary books, supplies, and equipment.
You can benefit from a tax deduction for:
— Interest paid on student loans you have taken out for yourself, your spouse or a dependent. You can deduct up to $2,500 for the year, depending on the amount of interest you paid and your income.
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