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You Should Know The Basics About Student Loans And Taxes, These Are Important Points

There are more than 45 million people with student loans in the United States. So, as the end of the year approaches and people start getting ready, it makes sense to ask, “How do student loans affect taxes?”

Student loans usually don’t have a big effect on your taxes, which is good news. Since they are loans and not income, they will not make your tax bill go up. And if you paid, you might be able to get a tax break.

Even though your student loans could help lower your tax bill, there are times when they can hurt your tax situation. Read on to find out more about taxes and student loans.

What do student loans have to do with taxes?

In the five ways below, student loans can affect your taxes:

1. You might be able to get a tax break

Are student loans tax deductible? The total amount you pay to pay off your debt is not tax-deductible, but the interest you pay on it might be.

You may be able to get a tax deduction for your student loan interest if you have either federal or private student loans. If you qualify, you can deduct $2,500 or the actual amount of interest you paid on your student loans, whichever is less.

The tax deduction for student loan interest is above the line, so you can claim it even if you don’t itemize your deductions. Your taxable income can go down because of the deduction, which can help you save money.

The deduction is not open to everyone. If your modified adjusted gross income is less than $70,000 ($140,000 if you are married and file a joint return), you can claim the full amount. If your income is between $70,000 and $85,000, or between $140,000 and $170,000 for a married couple filing jointly, you can claim a smaller amount. If your income is more than those amounts, you can’t get a tax break for student loans.

You can get the deductions if you meet the following conditions:

  • You paid interest on a loan that was eligible.
  • You are required by law to pay back the loan.
  • You are not married but filing separately.
  • Your income isn’t too high or too low.
  • No one can claim you or your spouse as dependents on their tax return.
  • The lender will send you a Form 1098-Student Loan Interest
  • Statement if you paid $600 or more in interest on a qualified student loan. You can fill out your tax return with that form.

2. If your loans are cancelled, you may have to pay a lot of taxes.

Forgiveness of student loans has been a big deal. Before, loans that were forgiven through certain programs, such as income-driven repayment plans, were counted as income and had to be paid taxes on. If the government gave you a lot of money back, you might get a big tax bill.

That changed with the American Rescue Plan. Thanks to the American Rescue Plan, you don’t have to report forgiven federal loans as income on your federal tax return between 2021 and 2025. But you can’t say the same thing about state tax returns.

Depending on where you live, you might have to pay state income taxes on the amount of your loan that was forgiven. Seven states still plan to tax loan forgiveness, but that could change in the future:

  • Arkansas
  • California
  • Indiana
  • Minnesota
  • Mississippi
  • The state of North Carolina
  • Wisconsin

3. Employer repayment programs are tax-exempt (for now)

According to the Employee Benefit Research Institute, 17% of employers have programs to help with paying back student loans. Most of the time, these programs work like retirement plans offered by employers. The company will match their employees’ student loan payments up to a certain limit each year.

Thanks to a federal law, employers can help their workers pay off their student loans without having to pay taxes on the money until 2025. Under current law, employers can contribute up to $5,250 per employee per year, and the amount of help is not taxed as income.

At the state level, student loan repayment programs offered by employers are not taxed yet. Using a student loan repayment program offered by your employer can be a smart way to save money and pay off your loans faster.

4. The government can take your tax refund if you don’t pay back your student loans.

Many people with student loan debt worry that the government will take their tax refund if they owe money. But that will only happen if you take out federal loans and don’t pay them back.

When you don’t pay your federal student loans for 270 days or more, you’re in default, and the government can take your refund through a treasury offset. It can keep your refund and put the money toward the balance of your loan instead.

Private student loans are not affected by this rule.

Questions about taxes and student loans

Here are the answers to some of the most common questions about how student loans and taxes are related.

Are student loans tax deductible?

You can’t write off all of your student loans on your taxes. But if you meet certain income requirements, the student loan interest deduction may let you deduct up to $2,500 in interest.

Can I use the tax deduction for student loan interest on a private student loan?

Yes, both private and federal student loans are eligible for the tax deduction for student loan interest.

Do scholarships and grants have to be paid back?

In general, scholarships and grants that are used to pay for school are not taxed. If you get a scholarship or grant that pays for things like textbooks or room and board, the amount of the award may be taxed as income.

Can my tax refund be taken by lenders?

If you haven’t paid back your federal student loans, only the federal government can take your tax refund. If that happens, the loan servicer can take a number of actions, such as treasury offset, taking your tax refund, or garnishing your wages.

Getting ready for tax time

As the year winds down, it’s a good idea to start thinking about taxes and making plans. If you still owe money on your student loans, you can save money by learning about tax deductions and other tax benefits.

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