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Major life events and financial transactions, such as changing jobs or buying a home, can affect your taxes. This is also the case with federal and private student loans.
Whether you’re considering taking out student loans, about to start paying them back, or have been making payments for a while, this article will explain the potential tax implications of student loans.
If you’re considering refinancing your student loans, Credible lets you compare student loan refinance rates from various lenders in minutes.
Does the IRS consider student loan income taxable?
When you take out a federal or private loan, you must repay the full amount with interest. So even if your college or university’s financial award letter calls these loans part of your “award,” they are not taxable income as far as the IRS is concerned.
When financial assistance may be taxable
Student loans are not taxable income, but other forms of financial aid may be. In general, scholarships, grants, fellowships, and tuition reductions are tax-exempt as long as they meet the following conditions:
- You are preparing a degree in an eligible financial institution.
- They do not exceed your eligible educational expenses.
- They are not used for other purposes, such as board and lodging.
- They do not represent payment for a service, such as teaching or research.
A portion of your scholarship, grant, or fellowship may be taxable if it exceeds your eligible tuition and related education costs. For example, if you receive a $20,000 scholarship, but your total tuition, fees, and course-related expenses are only $17,000, the difference of $3,000 is taxable income. .
You can learn more about the rules for excluding different types of financial assistance from your taxable income in IRS Publication 970.
Deduct student loan interest from your taxes
If you’re new to student loans, you might be surprised to learn that student loans are more likely to result in a tax deduction than a tax burden.
IRS rules allow you to deduct up to $2,500 in student loan interest per tax year. You claim the deduction as an adjustment to income, which means you don’t need to itemize to claim it. You can claim the interest deduction on student loans, whether your loans are federal or private, as long as the loans are used for eligible educational expenses, including:
- Tuition and Fees
- Room and board
Eligibility for the student loan interest deduction
You must follow a few rules to take advantage of the student loan interest deduction. First, you must have paid the interest on an “eligible student loan”, which means you used the loan to pay eligible education expenses that were:
- For you, your spouse or a dependent
- Repaid within a reasonable time after taking out the loan
- Provided while you were enrolled at least half-time in a degree or certificate program
How much is the deduction worth
The student loan interest deduction is worth up to $2,500, but is being phased out for high-income taxpayers.
The phase-out begins once your Modified Adjusted Gross Income (MAGI) exceeds $70,000 ($140,000 if you are filing jointly with your spouse). If your MAGI is $85,000 or more ($170,000 or more if you are filing jointly), you cannot claim the deduction at all.
MAGI is usually your adjusted gross income (AGI) from your Form 1040, but with a few added items, such as your student loan interest deduction and non-taxable foreign income or housing allowances.
If your income is in the phase-out range, you calculate your deduction by multiplying your student loan interest (capped at $2,500) by a fraction. Publication 970 also includes a worksheet to help you calculate your deduction.
What to know about Form 1098-E
If you paid interest on a student loan during the year, you should receive Form 1098-E from your student loan officer or lender in late January or early February of the following year. This form shows the amount of interest you paid during the year. The loan officer also sends a copy of Form 1098-E to the IRS.
It is important to note that IRS rules only require a lender to send the form if they received $600 or more in interest during the year, so you may not receive Form 1098-E, even if you paid interest on a qualifying student loan during the year.
If you paid interest on a qualifying student loan and did not receive Form 1098-E from your loan servicer, check your year-end statement or online account to determine the amount of interest you you paid and calculate your deduction.
With Credible, you can compare student loan refinance rates from multiple lenders, all in one place.
How student loan forgiveness can affect your taxes
When your student loans are forgiven, you are no longer required to repay some or all of your loans. The Department of Education offers several student loan forgiveness programs for federal borrowers, including those for people working in government or as teachers.
The IRS generally considers canceled debt as taxable income. For a time, some student loan forgiveness was taxable and some was non-taxable. However, thanks to a provision included in the American Rescue Plan Act of 2021 (ARPA), this is no longer the case, at least for now. ARPA has made all types of student loan forgiveness tax-exempt until December 31, 2025.
Education-Related Tax Breaks You Need to Know
Although the student loan interest deduction benefits you after you’ve left school and started paying off your loans, there are several tax breaks that can help lower your tax bill while you’re still in school.
Here’s an overview of each of the education-related tax breaks you need to know about and how to qualify for them.
US Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) provides a tax credit to help offset tuition, fees, and course materials required to attend the first four years of college or university. It is worth up to 100% of your first $2,000 and 25% of your next $2,000 of eligible educational expenses, for a maximum credit of $2,500.
The AOTC is a partially refundable credit, which means that if it reduces the amount of tax you owe to zero, up to $1,000 of the credit can be refunded to you.
Although the AOTC is the most generous education tax credit, it also has the strictest requirements. To qualify, you must be enrolled at least half-time for at least one academic term (such as a semester), and it is only available for the first four years of your undergraduate studies.
The AOTC also has income limits based on your MAGI. Your MAGI must be $80,000 or less ($160,000 or less if married and filing jointly) to claim the full credit. If you are a single taxpayer with a MAGI between $80,000 and $90,000, or married and filing a joint return with your spouse and you have a MAGI between $160,000 and $180,000, you are entitled to a tax credit. partial tax. You cannot claim the credit if your income is above these upper thresholds.
You can claim the credit by completing Form 8863 and submitting it with your tax return.
Lifetime learning credit
The Lifetime Learning Credit (LLC) is another tax credit to help offset the cost of tuition and university fees. It is worth up to 20% of your first $10,000 of eligible education expenses, up to a maximum of $2,000 per return.
Unlike the AOTC, none of the LLCs are redeemable. But it’s usually more available because it’s not limited to your first four years of graduate school, and you don’t need to be enrolled at least half-time to claim it.
The LLC only applies to tuition and required fees paid directly to your college or university. It also has income limits. Your MAGI must be $59,000 or less ($118,000 or less if filing jointly with your spouse) to claim the full credit. You cannot claim the credit if you are single and have a MAGI of $69,000 or more ($138,000 or more if you are married and filing jointly). If your MAGI is in the phase-out range, you may qualify for reduced credit.
Tax Free 529 Withdrawals
Saving for college with a 529 plan offers various federal and state tax benefits.
First, while you won’t get federal tax relief for contributing to the 529 plan, many states offer a tax deduction or tax credit if you contribute to a plan in the state.
Second, income generated from the account is not subject to federal income tax, allowing your money to grow tax-free.
Finally, as long as you use withdrawals from the plan to pay for eligible educational expenses, your distributions are not subject to federal or state income tax. Eligible education expenses generally include:
- Tuition and Fees
- Books, supplies and equipment
- Special needs expenses
- Accommodation and meals (as long as you are registered at least half-time)
- A computer, software and Internet access
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