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While your student loans typically cost you money, there are several ways your student loans can help you save money on your federal income tax return. It’s important to make sure you review how each potential tax break works and whether it has recently changed before you file your taxes or prepare any tax planning.
If you’ve entered repayment on your student loans then you may want to consider refinancing. If you have strong credit or have a cosigner who does then you could end up saving a lot of money by qualifying for a lower interest rate. See some of your best options.
How Student Loans Impact Taxes
There really aren’t any negative impacts to your taxes from your student loans, other than you may have less money to pay what you owe in taxes. However, there are several different potential tax breaks or deductions that could help you lower your overall tax liability for the year.
What Are Tax Credits?
Tax credits provide you with a break on how much tax you owe. It’s much like getting credit at a retail store. When you return something without a receipt you may get store credit to make future purchases. So when you buy something you use that credit and don’t have to pay the amount of the store credit you have. The tax credit reduces your tax liability in the same way.
What Are Tax Deductions?
Another tax break is a tax deduction which actually reduces your taxable income. This limits how much of your income is calculated in your final tax liability.
Other Tax Implications
You may also qualify for assistance in repaying your student loans or in total forgiveness of some or all of your loans. This type of benefit could be taxed as income to you, though, so it’s important to understand how that works before agreeing to move forward.
As you can see, there are two different ways that student loans might impact your taxes. We’ll cover the major tax breaks, of both credits and deductions, for student loans and explain what each could mean for you.
Student Loan Interest Deduction
The student loan interest deduction provides an above-the-line exclusion from income for up to $2,500 in interest paid on federal and private student loans. This tax deduction can save you a few hundred dollars on your federal income tax return.
But, the word “paid” is the key to getting this tax break.
If you qualified for the student loan payment pause and interest waiver on your federal student loans, you cannot qualify for the student loan interest deduction on those loans because you didn’t pay any interest on those loans during the payment pause.
Even if you opted to continue making payments on your eligible loans, your payments would have been applied entirely to the principal balance of the loan, since no new interest was accruing.
You might nevertheless be able to claim this tax break on some student loan interest if you meet these scenarios:
- You may have paid 2-3 months of interest prior to the start of the payment pause and interest waiver in March 2020
- You may have paid interest on private student loans and commercially-held FFELP loans that were not eligible for the payment pause and interest waiver
So, your student loan interest deduction for 2020 (and 2021) may be lower than in previous years. But, not having to pay any interest yields greater savings than being able to deduct the interest on your taxes.
For 2023, the student loan interest deduction is phased out for modified adjusted gross incomes between $70,000 and $85,000 ($145,00 and $175,000 if filing jointly).
Tax-Free Student Loan Forgiveness
Some types of student loan forgiveness is tax-free. This includes loan forgiveness for working in particular occupations, such as Teacher Loan Forgiveness and Public Service Loan Forgiveness.
Student loan discharges may also be tax-free. This includes closed school discharges, false certification discharges, unpaid refund discharges and defense to repayment discharges.
The Tax Cuts and Jobs Act of 2017 made death and disability discharges of student loans tax-free, but only through the end of 2025. It is likely that this benefit will be extended after 2025, maybe even permanently.
The forgiveness of federal student loans after 20 or 25 years in an income-driven repayment plan is taxable under current law. The IRS treats the cancelation of debt like income to the borrower, who will receive a 1099-C. However, a borrower who is in an income-driven repayment plan for two decades is probably insolvent, with total debt exceeding total assets. Student loan borrowers who are insolvent can file IRS Form 982 to forgive the tax debt that results from the cancellation of student loan debt. Read IRS Publication 4681 for more information.
During the COVID-19 pandemic, a payment pause and interest waiver suspended the repayment obligation on federal education loans held by the U.S. Department of Education. The suspended payments are treated as though they were made for the purpose of federal student loan forgiveness and loan rehabilitation programs. In a way, this provides borrowers who are pursuing public service loan forgiveness with partial loan forgiveness since the suspended payments effectively increase the amount of forgiveness the borrower will eventually receive.
Tax-Free Employer-Paid Student Loan Repayment Assistance Programs
The CARES Act made employer-paid student loan repayment assistance programs, or LRAPs, temporarily tax-free in 2020. Subsequent legislation extended the tax-free status through the end of 2025.
Up to $5,250 in employer-paid educational assistance, including tuition and LRAPs, is tax-free.
Ask your employer to consider offering an LRAP if they don’t already. Not only do LRAPs provide a great recruiting and retention incentive for employees, but they also provide the employer with some tax savings, not just the employee.
Tax Deductions and Credits for College Students
There are a number of deductions and credits you can take advantage of if you’re attending school and your loans are in deferment. Some of these are only beneficial up to a certain amount. These tax breaks include:
- Tuition and fees deduction
- American opportunity tax credit
- Lifetime learning credit
- Earned income tax credit
You read our guide to tax breaks for students and parents to learn more.
Using a 529 Plan to Repay Student Loans
The Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, expanded 529 college savings plans by allowing up to $10,000 per borrower in tax-free student loan repayment as a qualified expense.
This benefit is available to the 529 plan’s beneficiary and the beneficiary’s siblings. With a change in beneficiary, parents can also benefit from this student loan tax break.
The $10,000 cap is a lifetime limit per borrower.
Note that not every state conforms to federal law. So, some states will treat student loan repayment as a non-qualified distribution for state income tax purposes even though it is tax-free for federal income tax purposes. In these states, the income portion of a nonqualified distribution is subject to ordinary state income taxes, plus possible recapture of state income tax credits or tax deductions attributable to the distribution.
The SECURE Act became law on December 20, 2019. Although the legislation was retroactive for all of 2019, most borrowers who use qualified distributions from 529 plans to repay student loans will do so in 2020 or a subsequent year.
The Bottom Line
There are plenty of opportunities that you can take advantage of in order to lower your overall tax liability. These may include deductions, credits or repayment assistance programs. Each impacts your taxes in a different way so it’s important to know how each works before you use them so that you can plan your taxes accordingly.
Frequently Asked Questions (FAQs)
Do you pay taxes on student loans?
No, you don’t pay taxes on the amount of money you owe for student loans. You may be able to apply for tax relief because of student loans, though, and any forgiveness or assistance you receive to pay student loans may count as taxable income.
How do I report student loans on my taxes?
Your loan servicer or school should send you a 1098-E form to show how much student loan interest you’ve paid over the last taxable year. You’ll need to fill out that in the proper section on your tax return.
Are student loan payments tax deductible?
You can deduct interest that you pay throughout the course of the year that you’ve paid for student loans. However, those student loans must have been taken out to pay college expenses for yourself, your spouse, or your dependent.
