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How will student loans impact my taxes?

December 08, 2018

If you have student loans, then you may be wondering how they will affect you at tax time.  The good news is that you can deduct interest paid on the loans, but depending on your repayment plan, there are additional important aspects that you need to consider.

Student Loan Interest Deduction

The interest you pay on student loans is tax-deductible, provided that all of the following criteria is met:

  • The student is you, your spouse, or your dependent;

  • The student attends or graduated from an eligible education institution;

  • The student is (or was, if the degree program has been completed) enrolled in school at least half time (generally, this means completing 6+ credits per semester);

  • The lender is the federal government or a private institution, not a family member or employer (the loan cannot be provided by tax-qualified retirement plan);

  • The loan proceeds were spent on qualifying education-related expenses [“what qualify as education-related expenses?”];

  • You do not file taxes as married filing separately; and

  • Your modified adjusted gross income is annually less than $80,000, or $160,00 for married couples filing jointly.

Borrowers who meet all of the above criteria are eligible to deduct up to $2,500 from their taxable income for student loan interest expenses.  According to the IRS, student loan interest is an above-the-line tax deduction, which means that you are not required to itemize any expenses in order to claim the deduction.  

Tax Filing Status Considerations for Married Couples

While you cannot deduct student loan interest expenses from your taxable income if you are married but file taxes separately from your spouse, you may still want to consider paying taxes separately.  If you are enrolled in an income-driven repayment plan for your student loans, then your monthly payment is limited to a fixed percentage of your discretionary income.  (Another perk of the program is that unpaid loan balances are forgiven after 20 or 25 years.) However, it is important to realize that under an income-driven repayment plan, your income is determined by the taxable income that you report to the IRS.  If you are married and file taxes jointly, then you and your spouse’s income combined will be considered for the purposes of your income-driven repayment plan.  If your combined household income is high enough, then you may not even qualify for an income-based repayment plan.  Therefore, if you are married, you may want to consider filing taxes separately. The loss of the Student Loan Interest Deduction could be more than offset by lower monthly payments under an affordable income-driven repayment plan.

Tax Implications of Student Loan Forgiveness

If you are enrolled in an income-driven repayment plan or qualify for the Public Service Loan Forgiveness program, then your outstanding student loan balance is automatically forgiven after a certain number of years.  Pretty cool, right? Yes, but there are important tax implications to consider. While participants in the Public Service Loan Forgiveness program are not taxed on their forgiven balances, borrowers who utilize income-driven repayment plans are not so lucky.  These borrowers, in the year that their remaining debt is forgiven, are required to pay income tax on the forgiven amount. Although that year may be far in the future, students or parents with large loan balances may face a very substantial tax bill when the time eventually comes.  

If you are enrolled in one of these programs, you may be wondering how much of your debt will be forgiven.  The Federal Student Aid Office of the U.S. Department of Education provides this handy Repayment Estimator tool to compute loan payments and forgiveness under different repayment programs.  Borrowers can utilize this tool to explore all the available repayment options available to them.

Need More Information?

If you or your dependent is still enrolled in school, check out the IRS’s useful Interactive Tax Assistant tool to determine your eligibility for education-related tax credits and deductions.