Student Loans and Taxes: Some Basics to Know

The federal student loan pause has been extended and student loan cancellation for some borrowers has been announced—but there are some other things you should know about student loans and taxes.

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If you are one of the one in five Americans that has student loan debt, there’s good news—student loan debt cancellation is available, and student loan payments and interest are on pause through the end of 2022. But if loan cancellation doesn’t wipe out your student loan balance, you’ll be back to making payments in 2023. That's why it’s good to hit the refresh button on some basics regarding student loans and taxes.

Student Loans Are Not Considered Income

A typical question surrounding student loan debt is whether a student loan is income for tax purposes. The fortunate answer is no, the IRS doesn’t consider student loans to be income.

Income that is taxable is usually made up of salary and wages. The IRS also considers unearned income (e.g., winnings or profits from sales of assets or stocks) to be taxable. So, because student loans are debts that are intended to be repaid with interest, they are not taxable income and do not need to be reported as such on your tax return.

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Is Student Loan Interest Deductible?

Additional good news about student loans and taxes is that you may be able to deduct the interest that you pay on your student loan on your tax return. That deduction can potentially save you a little money at tax time.

Right now, due to pandemic relief and President Biden's recent announcement, payments and interest on student loans are on pause until the end of December. However, normally, when you pay interest, the IRS allows you to deduct either the amount of interest you paid during a given tax year, or $2,500, whichever is less. And, you don’t have to itemize your deductions to claim student loan interest because the IRS considers student loan interest to be an adjustment to your income.

To claim the student loan interest deduction, you must have paid interest on what the IRS calls a “qualified student loan.” That is essentially a loan that was taken out to pay for higher education expenses for you, your spouse, or a dependent.

But whether you can claim a deduction for student loan interest also depends on several other factors including on your filing status and income. That’s partly because the student loan interest deduction phases out depending on the amount of your modified adjusted gross income.

For example, if you are married and want to claim the student loan interest deduction, you cannot file separately, and you and your spouse cannot be claimed as dependents on someone else’s tax returns. Also, your modified adjusted gross income must stay within a specified amount.

In 2022, if your modified adjusted gross income is less than $70,000 (if you’re single) or $145,000 (if you’re married filing jointly), you could deduct the amount you paid or $2,500, whichever is less. However, single filers whose modified adjusted gross income fell between $70,000 and $85,000 or married filers whose income fell between $145,000 and $175,000, would have their student loan interest deduction reduced. This is because their modified adjusted incomes are higher.

More information about the student loan interest deduction can be found on the IRS website.

2022 Student Loan Forgiveness is Nontaxable (For Now)

While it’s important to know whether student loans are income and whether you can deduct student loan interest on your taxes, some wondered whether President Biden's student loan cancellation would be taxable. That's because whether you were taxed on the forgiven amount of your federal student loan was complicated, partly because of the various types of student loan programs and repayment plans.

Typically however, the IRS treats cancelled and forgiven debt as taxable income. But there are some important exceptions to this that have applied recently to student loans, mainly because of legislation passed during the COVID-19 pandemic. For example, student loan borrowers whose loans were forgiven as part of the Public Service Loan Forgiveness program, are currently exempt from tax on the forgiven amounts. (Eligibility for that program has also recently been expanded).

Also, the American Rescue Plan Act (ARPA) paused taxes on student loan forgiveness from 2021 through 2025. That includes people whose student loans are classified under the Income-Driven Repayment program. ARPA's broad relief also coverns other repayment programs, effectively making student loan forgiveness nontaxable for most borrowers.

Under President Biden's student loan cancellation plan, announced August 24, the Department of Education will provide student loan relief up to $10,000 to borrowers whose loans are held by the Department of Education, and whose income is less than $125,000 per year. (The income limit for married couples who file jointly is $250,000.) Loan relief of up to $20,000 is also available for Pell Grant recipients. Student loan payments will resume in January 2023.

For the 2022 student loan cancellation, the White House also announced that because of the loan relief provisions in ARPA, the 2022 student loan cancellation amounts will not be treated as taxable income. That means you should not be taxed on the amount of your student loan that is forgiven under this cancellation program.

Employer Repayment Assistance Could Be Taxable to You

In light of the pandemic in 2020, Congress passed the CARES Act, which contained provisions allowing employers to contribute money toward the federal or private student loans of their employees.

Under CARES, employers could directly contribute $5,250 each year tax-free to employees’ student loans. This employer student loan repayment assistance has been extended through 2025.

If your employer offers this benefit, it’s currently a way to reduce your student loan debt that is tax-free to you. However, because it’s a form of debt forgiveness, it is unclear-whether after 2025, when the tax relief is set to expire, employer repayment assistance for your student loan will, or won’t, be taxable to you.

Tax Problems if You Default on Your Student Loan

Data show that one-third of borrowers have already defaulted on their student loans—some more than once. But because of recent pandemic relief (mentioned previously) many borrowers who defaulted on their loans were able to have their good standing reinstated in the last couple of years. However, with current soaring inflation and looming recession, it’s hard to say whether that so called “fresh start” student loan relief will translate to fewer defaults.

Before default relief was put in place, the penalties associated with student loan default could be significant and included things like high negatives on your credit rating and wage garnishment. Tax consequences for defaulting on your federal student loan were also hefty. For example, the federal government could seize your tax refunds and even some of the refundable portions of certain tax credits.

Even though student loan payments are currently paused through December 31, 2022, if you think that you might default on your federal student loan, reach out to the Department of Education or your loan servicer to find out about any available loan rehabilitation program.

Various Tax Forms Associated with Student Loans

When you have a student loan, the interest you pay on it is reported to you on Form 1098-E if you paid at least $600 in interest during the tax year. (But remember, you probably didn’t pay interest recently because of the pause on student loan interest and payments).

Normally Form 1098-E is mailed to you, but you can also find a copy of your Form 1098-E on your loan servicer’s website or by contacting your loan servicer. You use the information provided on the form to claim the student loan interest deduction.

Another tax form that can be related to your student loans is Form 1098-T, which shows the amount of qualified tuition and related education expenses that you paid during the tax year. Form 1098-T can be useful in claiming education tax credits that might also help to reduce your tax bill.

Kelley R. Taylor
Tax Editor, Kiplinger.com