You may think that your student loans have little to do with your income taxes, but you’d be wrong. An important thing to note right off the bat is that the money you borrow when you take out a student loan isn’t considered taxable income.
However, many other facets of the tax law may apply to your student loans, from the deductibility of your interest to taxes potentially owed on forgiven loans. Here are the most important things you should know about how your student loans may impact your tax return.
Student Loan Interest Deduction
Student loan holders receive an important tax break in the form of the student loan interest deduction. Per the IRS, when you pay interest on a qualified student loan, either through voluntary or required prepaid interest payments, you can deduct the lesser of $2,500 or the amount you actually paid in interest during the year.
One trap that student loan holders should avoid when filing their taxes in 2023, however, is that most of them didn’t pay any student loan interest during 2022. As most student loan payments were suspended during the year, most borrowers didn’t pay any interest, and therefore don’t qualify for the deduction. Remember, even if interest accrues on your account, you don’t qualify for the deduction until you actually pay the interest.
Since payments weren’t paused on private loans or Federal Family Education Loans, you may still qualify for the interest deduction. Also, you should note that there are income limits for the student loan interest deduction as well. Singles with incomes above $85,000 or joint filers with incomes above $170,000, for example, do not qualify.
Taxes on Forgiven Loans
In the most general sense, the IRS considers forgiven debt to be taxable income. If you negotiate a settlement with your credit card company to forgive some of your debt, for example, the amount that you no longer have to pay is considered taxable income. It might seem like this rule would apply to student loans that are forgiven as well. After all, you borrowed the money and no longer have to pay it back, so it seems like it is just like credit card debt in that sense.
The great news for student loan borrowers is that forgiven loans are not considered federally taxable income. In this sense, forgiven student loans are more like the Paycheck Protection Loans that the federal government forgave during the pandemic, which were not treated as taxable income.
An important thing to note, though, is that while your forgiven student loans are not considered federally taxable, they may be taxable at the state level. You’ll have to check with your state taxing authority to determine the status of your forgiven student loans.
American Opportunity Tax Credit or the Lifetime Learning Credit
Depending on your financial situation, you may qualify for an educational credit of up to $2,500. Both the American Opportunity Tax Credit and the Lifetime Learning Credit are available to qualifying individuals, but you can only take one, not both. Income limits apply to these tax credits as well.
Specifically, the American Opportunity Tax Credit refunds up to $2,500 for qualifying educational expenses during the first four years of higher education. Up to 40% of the credit, or up to $1,000, is fully refundable, meaning you can receive that payment even if your tax liability is zero.
The Lifetime Learning Credit of up to $2,000 per year can be claimed an unlimited amount of times to offset qualified tuition and related expenses. The credit applies to expenses incurred for undergraduate, graduate, and professional degree courses.
Both the AOC and the LLC completely phase out if you have a MAGI of at least $90,000 for singles or $180,000 for joint filers.
Employer Student Loan Repayment
Some employers have tuition repayment plans in place to help their employees with their student loan payments. If your employer participates, it can kick in up to $5,250 per year toward your student loan costs.
Although this may feel like a type of employee compensation, which would normally be taxable, the IRS has ruled that “employer-provided educational assistance benefits include payments made after March 27, 2020, and before January 1, 2026” are excluded from income. This is true whether the payment is made to the employee or directly to the lender. Bear in mind that this provision is currently slated to expire at the end of 2025.
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