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If you have student loans, don’t forget about them at tax time. Student loans can have several implications on your federal tax return, ranging 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 be eligible for the student loan interest deduction
You can deduct the interest you pay on your student loans. The student interest deduction reduces your adjusted gross income (AGI), which can help you qualify for other deductions and tax credits with AGI limits. However, you are limited to deducting $2,500 in 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 income.
For 2021 tax returns (those due April 18 of this year), you get the full deduction if your modified adjusted gross income (MAGI) is $70,000 or less if you are a single filer, head of eligible family or 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 you are married and filing jointly), your deduction is phased out. Worksheet 4-1 in IRS Publication 970 contains a worksheet to help you calculate your deduction, but if you use tax software to prepare your return, the software will calculate it for you.
Once your MAGI exceeds the upper phase-out threshold, you can no longer claim the student loan deduction at all.
Here are some other rules to note. You cannot claim the student loan interest deduction if:
- Your filing status is married, separate filing
- Someone else claims you as a dependent upon their return
- You are not legally obligated to pay the student loan
If you paid $600 or more in interest on an eligible student loan during the year, your lender or loan officer should send you Form 1098-E, Student Loan Interest showing the amount of interest you have paid. Even if you don’t receive this form, you can determine the amount of interest you paid by logging into your online account or calling your loan manager.
You claim the student loan interest deduction by entering your authorized amount on line 1 of Schedule 1, which is filed with your Form 1040. Its location on Schedule 1 means you can take advantage of the deduction even if you don’t elaborate.
Keep in mind that many federal student loan issuers suspended payments and had a 0% interest rate from March 13, 2020 through May 1, 2022. So if your loans qualified for the suspension, you won’t you may not have paid interest on student loans. in 2021, because your entire payment has been allocated to the principal of the loan.
However, private student loans were not part of the U.S. Department of Education’s student loan payment break, so you may have been paying interest on private student loans.
2. Canceled or forgiven student loan debt might not be taxable
Generally, 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, with some exceptions.
In 2021, the Biden administration wrote off about $11 billion in student loan debt. And earlier this year, Navient, one of the nation’s largest student loan managers, announced it would cancel $1.7 billion in private student loans to settle lawsuits accusing the company of issuing loans to borrowers who could not afford to repay them. Does that mean the hundreds of thousands of borrowers who received student loan forgiveness last year could face hefty tax bills this year? Not necessarily.
It depends on how the loans were canceled. Several student loan forgiveness programs, including the Public Student Loan Forgiveness (PSLF) program, the Total and Permanent Disability Discharge (TPD) program, and the Borrower Defense to Repayment program, have resulted in debt forgiveness free of tax for years.
Additionally, the American Rescue Plan Act (ARPA) allows taxpayers whose federal or private student loans were canceled for any reason from 2021 through 2025 to exclude debt cancellation from their taxable income.
Not all loans made for educational purposes qualify for the exclusion, and while some states follow the federal treatment for canceled student loans, not all do. If you have canceled or forgiven student loan debt, discuss the tax treatment with your CPA or tax advisor.
Read more: Is student loan forgiveness taxable in 2022? It is complicated.
3. Student loans in arrears? The Treasury Department may accept your refund
If you haven’t repaid your federal student loans, the federal government could garnish any federal tax refunds you might expect.
The Treasury Compensation Program (TOP) collects overdue debts that individuals and businesses owe to state and federal agencies — including overdue child support, state and federal tax debt, and defaulted student loans — from various federal payments.
If your tax refund is seized by TOP, your options to recover it are limited.
- Injured spouse. If you are married and filing jointly with your spouse, their delinquent student loans could cause TOP to garnish your tax refund. To avoid this situation, consider filing separate returns. If you filed jointly, consider submitting Form 8379, Injured Spouse Allowance, to recover your share of the refund. You may be considered an “injured spouse” if, for example, your refund was garnished for your spouse’s delinquent student loan that he or she took out before you got married.
- Collection errors. If you have already paid off your delinquent student loan or if you think you do not owe the debt for another reason, contact the Department of Education or your loan officer.
The Department of Education must give you 60 days notice before sending your debt to TOP and give you the opportunity to enter into a payment agreement or dispute the debt.
Before you sit down to file your taxes, log into your account on your student loan manager’s website to see if you’ve paid interest on your federal or private student loans. If you did, be sure to take the Schedule 1 deduction, assuming you meet the income requirements outlined above.
Also check to see if the Department of Education has canceled or waived any of your student loan debt. You may want to discuss the situation with a tax advisor to ensure that the forgiven debt is not taxable.