How student loans impact your taxes

Student loans can open the door to educational opportunities you otherwise might not be able to afford. However, paying student loans after graduation often becomes a source of financial stress. One way to make that stress lighter is by taking advantage of tax credits and incentives.

You can likely receive a tax break when you start paying off your student loans, and there are also a few tax credits available for current students. Student loan payments can reduce your taxable income by up to $2,500 and, if you’re still in school, give you a tax credit of up to $2,500.

How student loans affect your taxes before and after school

Whether you’re still in school or have graduated, your loans may reduce the amount you owe to the IRS through education tax credits, including the student loan interest deduction, the American opportunity tax credit and the lifetime learning credit.

In addition, you do not need to pay taxes on your student loan. Student loans are not considered taxable income because you’re obligated to pay them back.

Student loan interest deduction

Depending on your income and tax-filing status, you may be able to deduct up to $2,500 in student loan interest from your taxable income each year.

What you can deduct

With this deduction, the IRS specifically focuses on what you paid in interest to your lender. The actual loan payment itself isn’t deductible — only the interest you’ve paid off is.

You can deduct either $2,500 or the full amount of student loan interest you paid in the taxable year, whichever is less. In other words, this deduction caps out at $2,500.

Qualifications

You can explore taking this deduction whether you pay federal or private student loans.

The deduction, however, is set up so that the more income you earn, the less student loan interest you can write off. Once your income reaches the limit set by the IRS, the deduction goes away altogether.

The income limits for the student loan interest deduction change each year. For the 2024 tax year, they are:

• Single, head of household and qualifying surviving spouse: The deduction starts to phase out when your modified adjusted gross income (MAGI) reaches $70,000. At $90,000, the deduction disappears completely.
• Married filing jointly: The deduction phaseout begins once your joint MAGI reaches $155,000. If your joint income surpasses $185,000, you can no longer claim the student loan interest deduction.

You can’t claim the student loan interest deduction if your filing status is married filing separately. You must file taxes jointly if you’re married and want to take this tax break.

The IRS provides an online form to help you figure out if you’re eligible. Even if you think that you might not qualify for the deduction, it’s worth checking. The student loan interest deduction could potentially save you hundreds of dollars on your tax obligation by lowering your tax bill or boosting your tax refund.

How to claim

To get this deduction, you claim it on your income tax returns (Form 1040). Unlike many other deductions, you don’t have to itemize your tax return to take advantage of the student loan interest deduction. Instead, you can claim the deduction as an exclusion from your income.

A mailed or emailed form from your student loan lender will tell you how much you can deduct. When you pay at least $600 in qualified student loan interest, your lender should send you an IRS Form 1098-E (Student Loan Interest Statement). You can use this form to claim the student loan interest deduction when filing your taxes.

If you paid less than $600 in student loan interest, you won’t receive a 1098-E form and will have to manually calculate how much interest you paid.

American opportunity tax credit

The American opportunity tax credit is worth up to $2,500 per student per year. It can be claimed for only four total tax years per student.

Up 100 percent credit is available for the first $2,000 worth of qualified education expenses annually. After that, a 25 percent credit is available for the next $2,000 of qualified education expenses each year.

The American opportunity tax credit has strict requirements, including:

• The student must be attending school at least half time for at least one academic term.
• The student must not have finished the first four years of a postsecondary program before the end of the tax year.
• The student must pursue a program that will end with a degree or other recognized credential.

The credit is phased out for single filers with a MAGI between $80,000 and $90,000 and joint filers with a MAGI between $160,000 and $180,000. Filers with MAGIs above those limits are not eligible.

The American opportunity tax credit is a tax credit, not a tax deduction. Although the two terms sound similar, the difference is significant. A $2,500 tax deduction simply reduces your taxable income by $2,500. This might reduce your total tax bill by $250 to $925, depending on your 2022 tax bracket. A $2,500 tax credit, on the other hand, would reduce your tax bill by the entire amount.

Lifetime learning credit

The lifetime learning credit is worth up to 20 percent of the first $10,000 in eligible education expenses — or up to $2,000 — per year per taxpayer. In addition, it has more lenient requirements than the American opportunity tax credit.

Here are the criteria:

• There is no minimum requirement for how many hours you need to be enrolled to qualify.
• There is no limit to how many years the credit can be claimed.
• Students do not need to be pursuing a degree or other recognized education credential; in other words, students can use this credit for courses focused on acquiring job skills or continuing education.

Like the American opportunity tax credit, the lifetime learning credit is a tax credit rather than a deduction. The income limits and phaseouts are the same for the 2023 tax year were: a limit of $90,000 for single filers and $180,000 for joint filers, with phaseouts beginning at $80,000 and $160,000 for single and joint filers, respectively.

You can’t apply both the American opportunity tax credit and the lifetime learning credit to the same education expenses. Generally, you’ll need to choose one or the other in any given tax year.

Student loan forgiveness and taxes

If your student loan debt is forgiven entirely, or even a portion is forgiven, you could be on the hook for an unexpected tax bill. That’s because, similar to other debts canceled by a creditor, the IRS considers forgiven student loan debt taxable income. The amount of debt that is forgiven becomes part of your gross income for the year and is subject to income taxes.

As part of the forgiveness process, student loan lenders will submit the forgiven balance to the IRS via Form 1099-C, Cancellation of Debt.

However, the type of student loan forgiveness you receive impacts whether you will be taxed. Those on income-driven repayment plans are most likely to be affected. Under income-driven repayment, any remaining student loan debt after 20 to 25 years of making payments is completley forgiven. The forgiven balance then becomes taxable income.

There are some exceptions. Student loan debt is not considered taxable income if it is eliminated through programs like the Public Service Loan Forgiveness or Teacher Loan Forgiveness. If your debt has been forgiven, speak with a tax professional to determine how your forgiven balances will be treated.

Taxes and 529 funds for student loan payments

According to the U.S. Securities and Exchange Commission (SEC), money in 529 plans can be used on a 100 percent tax-free basis when put toward qualified educational expenses, such as tuition and fees or room and board.

In most states, you can also use up to $10,000 in student loan payments from your 529 without incurring a penalty or having to pay taxes. These funds can be applied toward both federal and private student loans.

What happens to your taxes if you default on student loans

Defaulting on a student loan can hurt your credit score and cost you extra money. Your wages could be garnished and you could even have your tax refund withheld.

If you’re at risk of defaulting, take steps to set up a repayment plan or enroll in a forbearance program. Consider calling your loan servicer to create a plan to help you manage your monthly payments. You might be eligible for a hardship program, an income-driven repayment plan or a settlement.

Resources for tax help with student loans

Navigating student loans on your taxes can be tricky, but you should now feel more informed as you move forward. You don’t have to stop here, either. There are plenty of other resources available to help guide you through the process.

First, if you’re still in school, you can use this handy chart to explore the American opportunity tax credit and the lifetime learning credit to find which best suits you.

Those who want direct help from the IRS about those credits and the student loan interest deduction can access the IRS Publication 970, titled Tax Benefits for Education. This publication outlines tuition reductions, how to claim credits, how the interest deduction works and more.

If you feel unsure about filing your taxes yourself or which deductions or credits might apply to you, you can always contact a certified public accountant or explore other tax resources for help.