Earlier this week, President Joe Biden announced several efforts to ease student loans — most notably federal student loan forgiveness on $10,000 to $20,000 of borrower. With more than 43 million Americans holding roughly $37,667 in federal student loan debt per borrower (not counting private loans), many will see their debt balances shrink significantly, if not disappear entirely.
If your student loans are forgiven, or through the recent announcement, Community Service Loan Forgiveness Program or an income-driven repayment plan, will you have to pay taxes on the simplified balances? Here’s everything you need to know about student loans and taxes, and some additional tax breaks that could lower your tax bill in 2023.
Will you owe federal taxes on the unsecured student loan amount?
Provision inserted in US$1.9 Trillion America Rescue Act’s COVID Relief Package enacted in March 2021, eliminates federal taxation on student loan debt consolidation until 2025. This means you won’t owe any additional federal taxes on your student loan debt consolidation.
Typically, when you receive student loan forgiveness, your forgiven debt is added to your taxable income at tax season. This increases the amount of taxes you owe in a given year, or reduces your refund, or increases your tax bill.
For example, if you make $50,000 and have $20,000 in student loans forgiven, your taxable income will increase to $70,000, pushing you into a higher tax bracket.
For anyone who has just received forgiveness — or will receive in the coming months — your forgiven balance will be free of federal taxes.
What about government taxes?
This is a bit more complicated. While most states do not impose taxes on foregone student loan balances, Bloomberg reported that there are currently between 13 to 19 states that do not meet the provisions made in the Bailout USA Act and could pass laws that allow state taxes on foreclosed loans.
Although tax experts disagree on the number of states in which loan forgiveness can be taxed, popular opinion may make it difficult for states to do so. Jared Walczak, vice president of state projects at the Tax Foundation, told Bloomberg: “There’s going to be a lot of pressure on these states to follow the federal government’s approach and not include it in taxable income.”
Right now, it’s hard to say whether any states will impose taxes on foregone student loan balances. We will keep you updated as the situation develops.
Other tax considerations for those with student loans
In addition to student loan forgiveness optionsyou may be entitled to additional tax credits and deductions. Although the tax thresholds for 2023 have not yet been released, here are some student loan tax breaks that may increasing recovery in the following year or reduce your tax bill.
Student loan interest deduction
When you make monthly payments on your student loans, this includes the principal payment as well as any accrued interest payments. Whether you have private or federal student loans, student loan interest deduction allows you to reduce your taxable income depending on how much interest you paid. For 2021, that reduction reached $2,500 per year.
You qualify for the deduction if you paid student loan interest during the tax year and if you qualify for modified adjusted gross income (your income after allowable taxes and deductions). For 2021, you qualify if your MAGI was under $70,000 (or $100,000 if married filing jointly). Partial deductions were proposed for those with MAGI between $70,000 and $85,000 ($100,000 – $170,000 for those filing jointly).
With a federal student loan repayment pause and 0% interest, you may not have paid any interest in the last year. However, you should log into your student loan portal and check Form 1098-E for any eligible interest payments.
If eligible, this deduction will reduce your taxable income, which can reduce the amount you owe the IRS or increase your tax refund. You may even be placed in a lower tax bracket, which could qualify you other deductions and credits
American Opportunity Tax Credit
The American Opportunity Tax Credit is offered to first-time students in their first four years of higher education. Lets you claim 100% of the first $2,000 of qualified education expenses, then 25% on the next $2,000 spent—for a total of up to $2,500. If you are a parent, you can claim AOTC for an eligible student in your household as long as he is listed as a dependent.
To claim the full credit in 2021, your MAGI must have been $80,000 or less ($160,000 or less for those married filing a joint return). If your MAGI is between $80,000 and $90,000 ($160,000 to $180,000 for those filing jointly), you may have qualified for a partial credit.
The AOTC is a refundable credit, which means that if it reduces your income tax to less than zero, you may be able to get a refund on your taxes or increase your existing tax refund.
Lifetime Learning Credit
You can earn money back for qualified education expenses through Lifetime Learning Credit. An LLC can help pay for any level of continuing education courses (bachelor’s, master’s, and professional degrees). Transportation to college and living expenses are not considered qualified LLC expenses.
Unlike the AOTC, there is no limit to how many years you can claim the credit. You can receive up to $2,000 each year or 20% on the first $10,000 of qualified education expenses. The LLC is non-refundable, meaning you can use the credit to lower your tax bill if you have one, but you won’t get any of the credit back as a refund.
For 2021, you were eligible for this credit if you had qualified expenses and your MAGI was less than $59,000 ($118,000 for married filing jointly). You can also claim a reduced credit if your MAGI is between $59,000 and $69,000 ($118,000 and $138,000 for those who are married filing a joint return).
Note: You cannot claim both AOTC and LLC for the same student in the same tax year. If you qualify for both, the AOTC usually provides a greater tax break (and can increase your refund).
If your loans are delinquent, will next year’s tax return be garnished?
Typically, if you have defaulted on federal student loans (meaning you haven’t been able to pay what you owe on them for 270 days), your tax refund can be taken to help cover the outstanding balance. Because federal student loans were on hiatus during the 2022 tax season, your federal tax refund was not eligible for government garnishment.
It is not clear whether this will remain in place for 2023, although with the new payment pause due to expire at the end of 2022, this benefit may expire.
Your tax filing status can affect your student loan payments
If you are paying off federal student loans and are on an income-driven repayment plan, your marital status may affect the amount of your payment. For example, if you’re married filing jointly, your payments are based on the total income between you and your spouse. If you’re married and filing separately, your payments are based only on your income.
However, if you decide to file separately to reduce your monthly IDR plan payment, you may miss out on other key tax benefits. For example, you may not be able to take advantage of a lower tax rate extended to married couples filing jointly, nor will you be able to claim increased credit amounts and available deduction amounts if you file jointly.
The Revised Pay As You Earn, or REPAYE, plan does not distinguish between whether you are filed as married filing separately or married filing jointly. Your payments are based on the income of both you and your spouse.
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