Tax consequences and benefits of student loans
Student loan debt reached $1.34 trillion in the first quarter of 2017, up from $0.51 trillion 10 years earlier. The consequences for and benefits of taking out student loans go beyond career opportunities, lifetime earnings and other implications; like most things, it ends up on the tax return. Here is a look at the possible impact a student loan can have on a student’s tax situation.
Paying interest, deducting interest
When students start repaying their student loan, they can start deducting the interest – even if they don’t itemize their deductions. The maximum $2,500 deduction is “above the line,” meaning they don’t have to file a more complicated tax form to claim the benefit. This is a per tax return limitation, so married couples who are both repaying student loans cannot deduct more than $2,500 annually on their joint return.
Taxpayers can deduct student loan interest they pay on a loan they took out for themselves, their spouse or a dependent. For example, parents can deduct the interest on a loan they took out for their child’s education expenses. But parents cannot make payments for their child’s loan and take the deduction. In that case, where a student takes out a loan but the parent repays the loan, the parents are treated as providing a gift to the student and the student is treated as paying the loan.
Getting a job with loan forgiveness or repayment benefits
Some jobs offer student loan forgiveness as an employment benefit. Typically, the IRS considers forgiven debt to be income the taxpayer must report and possibly pay taxes on. However, if student loan forgiveness is part of a program to attract students to certain occupations or areas with unmet needs, the forgiveness could be tax-free.
Other employers may offer a repayment benefit. The amount an employer pays toward an employee’s student loan is taxable income to the employee. While the employee’s tax liability may increase because of the payments, the employee can partially offset this through their student loan interest deduction.
Canceling student loan debt after a school closes
Unfortunately, not every case of forgiven student loans is a positive one. After recent school closures across the country, students could have student loan debt for a school that can’t grant them a degree or certificate and can’t transfer their credits.
In this scenario, students with certain federal loans may apply for a closed school discharge of their debt. The forgiven amount is generally not taxable. Not all students and not all loans will meet the qualification criteria and students (or their parents) may need to investigate other options regarding loans that were used for tuition.
Other loans, like those covering living expenses, could still be forgiven. However, the students could owe income taxes on the amount of forgiven debt. In this case, they will get a tax form in the mail reporting that amount as income and may need to include it on their tax return.
Even if they receive the tax form reporting their forgiven debt, students could still qualify to exclude that income from their tax return if they can show they were insolvent or qualify for another exclusion.
Defaulting on a student loan
If a student defaults on their federal student loan and does not apply for deferment or forbearance, they could face trouble at tax time. If they are owed a refund, the government can use their refund to repay certain debts, including a federal student loan in default. This is one of the reasons that students who have difficulty making their student loan payments should work with the lender to make a repayment arrangement.
Student loan debt has grown at a startling rate over the last decade, which makes the tax consequences and benefits of student loans more important and relevant than ever. Students can learn more about the ways their education, such as student loan repayment plans, employer-provided educational assistance and scholarship income, affects their taxes at Get Answers.
By Annelise Wiens
As the newsroom editor, Annelise Wiens is interested in more than just tax and industry news, but the stories of H&R Block's 80,000 associates, their communities and H&R Block's world headquarters in Kansas City, Missouri. Wiens joined H&R Block in 2014 from a public relations agency, where she worked with clients in the financial services industry. Before that, she worked as a communicator for a senior member of the United States House of Representatives. She graduated from Biola University in La Mirada, CA with a bachelor's degree in history.