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Tax Implications of Student Loan Debt and Forgiveness

There are a few different ways that student loan debt affects your taxes, from possible deductions to what you may owe in the future.

 

You can deduct student loan interest from your income.

If you paid interest on student loans last year, you can lower your taxable income by up to $2,500.

Student loan borrowers can deduct the interest paid last year through the student loan interest deduction. The student loan interest deduction can reduce the amount of your taxable income by up to $2,500. Taken as an adjustment to income, you can claim a deduction on interest payments paid on qualified student loans even if you do not itemize deductions. The loan must have been borrowed while the student was enrolled at least half-time in a program leading to a degree, certificate or other recognized educational credential.

Your student loan servicer will send you a Form 1098-E statement if you paid $600 or more in interest last year. Ask your servicer for the document if you paid less than $600 in interest; you’ll still be able to deduct that amount, but you may not receive the form in the mail or by email without a request.

 

Filing taxes jointly may increase student loan payments.

Many graduates choose income-driven repayment plans to pay off their federal student loans. These plans limit your monthly payment to a percentage of your discretionary income. Plus, they forgive your loan balance after you’ve made payments for 20 or 25 years.

The way you file your taxes can significantly affect how much you owe on income-driven plans, though. If you file jointly with your spouse, your monthly payment will be based on the two incomes combined. That could increase your bill or even disqualify you from certain repayment plans if your income jumps high enough.

Because of this, many consider filing their taxes separately. The Income-Based and Pay as You Earn repayment plans will calculate your monthly payment using the student loan borrower’s income alone.

There are a few financial considerations and potential downsides to choosing married filing separately, though It’s always recommended to speak to a tax professional to ensure you may not be missing out on any tax benefits from filing jointly as opposed to separately.

To make it more complicated, Revised Pay as You Earn repayment option combines married borrowers’ incomes when it calculates your payment even if you file taxes separately. That might influence whether you choose this option to repay your loans.

 

Large Tax Bill Down the Line

You’ll get your federal student loans forgiven after a certain number of years if you take advantage of the government’s Public Service Loan Forgiveness program, or if you choose an income-driven repayment plan. But they work very differently

You’ll qualify for Public Service Loan Forgiveness after you’ve made 120 on-time loan payments while working full time at a non-profit or government agency. There’s an extra benefit, too: The forgiven amount won’t be taxed.

As it stands now, however, a borrower on an income-driven plan will pay income tax on the forgiven loan balance the year his or her repayment period ends. That means graduates or parents with large loan balances could be in for a big tax liability when it’s all said and done Speaking to a tax professional may offer some sound advice for what to do once that day arrives as far as creating a strategy to deal with the tax debt.

By: Stacey Walker and Robert Jacob of CCCS of Rochester

 

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