If you have outstanding student loan debt, taxes are likely the last thing you want to consider. But your student loans can have a substantial impact on your tax return. If you aren’t prepared, you could lose out on valuable deductions or get a surprise tax bill. How do student loans affect taxes? It depends on the type of loans you have and your state. Continue reading to learn about the important link between student loans and taxes.
Student Loans and Taxes: What You Should Know
Do student loan payments affect taxes? They absolutely can! Here are the most common ways student loans can affect your taxes:
1. You Could Be Eligible for the Student Loan Interest Tax Deduction
When you are making payments toward student loans, any help you can get can make a big impact. Whether you have private or federal student loans, you can claim the student loan interest tax deduction to reduce your taxable income. The student loan interest tax deduction is an “above the line” deduction, so you don’t have to itemize your taxes to claim it. If you’re eligible, the deduction will reduce your taxable income by $2,500 or the amount of interest you paid, whichever is less. However, there are income restrictions; the deduction is phased out as your income increases, and once it reaches a certain point, you may no longer be eligible. You can view the latest income limits on IRS.gov.
2. You May Have to Pay Income Taxes on Student Loan Forgiveness
Having your loans wiped out sounds like a dream come true. But in some cases, that dream can become a nightmare in the form of a huge tax bill. Luckily, some recent changes have made student loan forgiveness less of a tax burden, but there are some things you should know to ensure you’re prepared. Previously, loans forgiven through programs like income-driven repayment were taxable as income at both the federal and state levels. The amount of loan forgiveness would be taxed based on your tax bracket. The American Rescue Act was passed in 2021. It made student loan forgiveness tax-free through 2025. If you have loans forgiven through Public Service Loan Forgiveness or income-driven repayment, you don’t have to worry about federal income tax. The forgiven amount is not taxable if you are eligible for the new $10,000 or $20,000 loan. Currently, loans forgiven after 2025 may be taxable on federal income taxes, but this provision has the potential to be extended. Although the American Rescue Act eliminated federal income taxes on student loan forgiveness, it did not affect state income taxes. Depending on where you live, student loan forgiveness may still be considered income on state income taxes. If you expect some or all of your loans to be forgiven, talk to a tax professional in your state to plan for the upcoming tax season.
3. National or State Student Loan Repayment Programs (LRPs) May Be Taxable as Income
There are national and state LRPs that repay portions of your debt in exchange for a commitment to work in high-need areas for several years. How these programs are taxed varies by program and state. For example:
- John R. Justice: Lawyers that work as prosecutors at the state or local government level and public defenders can qualify for assistance with their federal loans through the John R. Justice program. According to the IRS, the assistance received through the program isn’t taxable at the federal level, but states may have different guidelines.
- National Health Service Corps (NHSC) LRP: The NHSC LRP provides up to $50,000 in student loan repayment assistance to primary medical, dental, and mental and behavioral health clinicians that commit to working in NHSC-approved communities. The funds provided through the program are not taxable as income.
- Florida Nursing Student Loan Forgiveness Program: Florida’s Nursing Student Loan Forgiveness Program repays $4,000 per year — for a maximum of four years — to licensed nurses that work in eligible state-operated medical facilities, public schools, or federally-sponsored community health centers. Payments through the program are exempt from federal income taxes, and Florida doesn’t have a state income tax.
4. Employer Student Loan Repayment Assistance Programs Are Currently Tax-Exempt
To compete with other employers for the best workers, more companies are offering additional benefits like student loan repayment assistance. With these programs, the employer will typically match your student loan payments up to a percentage of your salary or a flat dollar amount. For example, an employer may pay up to 3% of your salary toward your loans a year, up to a lifetime maximum of $10,000. Thanks to a provision in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, employers can contribute up to $5,250 toward employees’ student loan debt, and the contributions are free from payroll and income taxes through December 2025. Currently, employer student loan assistance programs aren’t taxed at the state level either. If your employer offers a student loan repayment program, taking advantage of it can help you pay off your loans faster and save a significant amount of money.
What About Student Loan Refinancing?
Student loan refinancing is a popular way to tackle your debt; you can potentially qualify for a lower rate and save thousands of dollars over the life of your repayment term. However, many borrowers worry that student loan refinancing will affect their taxes and cause them to owe more at tax time. However, student loan refinancing isn’t taxable as income. It’s another loan, so it doesn’t have to be reported as income, and you don’t have to pay taxes on the amount you borrow. You may be eligible for perks like the student loan interest tax deduction or loan forgiveness as a student loan borrower. Understanding how student loans and taxes are connected can help you prepare for the upcoming tax season and avoid surprises.
