If you have student loans, don’t forget about them at tax time. Student loans can impact your federal income tax return in several ways, from reducing your taxable income to losing your refund, depending on your situation. Here’s what you need to know.
3 Ways Student Loans Impact Your Income Taxes
1. You May Qualify for the Student Loan Interest Deduction
You can deduct the interest you pay on your student loans. Deducting student interest lowers your adjusted gross income (AGI), which can help you qualify for other deductions and tax credits with AGI limits. However, you’re limited to deducting $2,500 of student loan interest, and there are a few other rules and limits to keep in mind.
First, your deduction may be limited or eliminated if you earn too much.
For 2022 tax returns due in 2023, you get the full deduction if you have modified adjusted gross income (MAGI) of $70,000 or less as a single filer, head of household or a qualifying widow(er). For married couples who file a joint tax return, the amount increases to $140,000.
If your MAGI is between $70,000 and $85,000 ($140,000 and $170,000 if married filing jointly), your deduction is gradually phased out. IRS Publication 970 has a worksheet to help you calculate your deduction, but if you use tax filing software to prepare your return, the program will calculate the write-off for you.
Once your MAGI exceeds the upper phase-out threshold, you can’t claim the student loan deduction at all.
Here are a few other rules to note. You can’t claim the student loan interest deduction if:
- Your filing status is married filing separately
- Someone else claims you as a dependent on their return
- You’re not legally obligated to pay the student loan
If you pay $600 or more of interest on a qualified student loan during the year, your lender or loan servicer should send you Form 1098-E, “Student Loan Interest” showing how much interest you paid. Even if you don’t receive this form, you can determine how much interest you paid by logging into your account online or calling your loan servicer.
You claim the student loan interest deduction by entering your allowable amount on line 1 of Schedule 1, which gets filed along with your Form 1040. Its placement on Schedule 1 means you can take advantage of the deduction even if you don’t itemize.
Keep in mind that federal student loan issuers paused payments in mid-March of 2020 and have charged 0% interest since then. If you have federal loans, it’s probably been a while since you’ve had any interest to deduct. Private student loans have not been part of the U.S. Department of Education’s student loan payment pause, so you may have paid interest on private student loans.
Federal student loan payments and interest are scheduled to resume on January 1, 2023.
2. Canceled or Forgiven Student Loan Debt Might Not Be Taxable
President Joe Biden has announced a program to forgive up to $20,000 in federal student loan debt each, for tens of millions of borrowers. Applications for the relief have poured in, but the president’s plan is now tied up by legal challenges.
Typically, the IRS treats canceled or forgiven debt as taxable income. For example, if your credit card company agrees to settle your $10,000 balance for $4,000, the $6,000 of forgiven debt is taxable income, excluding a handful of exceptions.
But the American Rescue Plan—the massive COVID-19 aid bill that Biden signed in March 2021—allows taxpayers who have federal or private student loans forgiven for any reason from 2021 through 2025 to exclude debt forgiveness from their taxable income.
Several existing student loan forgiveness programs, including the Public Student Loan Forgiveness program, the Total and Permanent Disability Discharge Discharge program, and the Borrower Defense to Repayment program, have resulted in tax-free debt forgiveness for years.
Not all loans made for educational purposes qualify for the exclusion, and while some states follow the federal treatment of forgiven student loans, not all do. If you have any student loan debt canceled or forgiven, discuss the tax treatment with your CPA or tax advisor.
3. Defaulted Student Loans? The Treasury Department May Take Your Refund
If you’ve defaulted on your federal student loans, the federal government could seize any federal tax refund you might be expecting.
The Treasury Offset Program (TOP) collects delinquent debts that people and businesses owe to state and federal agencies — including past-due child support, state and federal tax debts, and defaulted student loans — from various federal payments.
If your tax refund is seized by TOP, your options for getting it back are limited.
- Injured spouse. If you’re married and file jointly with your spouse, their delinquent student loans could cause TOP to seize your tax refund. To avoid this situation, consider filing separate returns. If you filed jointly, consider submitting Form 8379, Injured Spouse Allocation, to get your share of the refund back. You may qualify as an “injured spouse” if, for example, your refund was seized for your spouse’s defaulted student loan that they took out before you were married.
- Collection errors. If you already paid your delinquent student loan debt or believed you don’t owe the debt for another reason, contact the Department of Education or your loan servicer.
The Department of Education must give you 60 days’ notice before sending your debt to TOP and give you an opportunity to work out a payment agreement or dispute the debt.
Before sitting down to file your taxes, log into your account on your student loan servicer’s website to see whether you paid any interest on your federal or private student loans. If you did, be sure to take the deduction on Schedule 1, assuming you meet the income requirements outlined above.
Also, check whether the Department of Education canceled or forgave any of your student loan debt. You may want to discuss the situation with a tax advisor to make sure the debt forgiven isn’t taxable.
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