Many students borrow money or take grants and scholarships to help pay for their higher education. Fortunately, you don’t report student loans as income on your tax return, and you don’t have to pay tax on some types of financial assistance.
But student loan debt that is settled or canceled is generally taxable.
If the IRS counts the money you received for your education as taxable income, it “has a direct impact on your taxes,” says Kristin Ingram, certified public accountant, clinical professor of accounting at the University of Hartford and owner of the Accounting in Focus accounting training website. “The more taxable income you have, the higher your taxes will be.”
Taxable income is your total income after deducting deductions and exemptions for the tax year.
If you use multiple ways to pay for your education, you might not understand what is taxable and worry about ending up with a big tax bill. Here’s what you need to know about how student loans can affect your taxes, as well as tax benefits that could reduce your burden.[Read: Best Private Student Loans.]
Are student loans considered income?
Uncle Sam does not tax federal or private student loans as income. But you might have to pay taxes on:
Portions of scholarships and grants. You will have to pay taxes on scholarships used for anything other than tuition, books, and supplies. If you received a scholarship of $ 15,000 and spent $ 12,000 on tuition but the rest on room and board, then you will owe taxes on the difference of $ 3,000.
You will also receive a tax bill on payments you receive for teaching or research required for scholarships or grants.
Tuition assistance programs provided by the employer. Some employers offer tuition reimbursement or student loan reimbursement to attract talent. The downside to these programs is that contributions made to employees may be taxable.
You will pay tax on any amount over $ 5,250 for your education in one year, and your employer must report the taxable portion on your Form W-2.
Student-athlete allowances. As with scholarships and grants, these allowances are taxed when used for accommodation and board or incidental expenses.
Federal work-study programs. Whether you receive a salary or an hourly wage as an undergraduate or graduate student, your work-study income is taxable. Your school will give you a W-2 form with all the information you need to report your salary.
What type of financial assistance is not taxable?
You will not have to pay tax on these types of student financial assistance:
Student loans. Private and federal student loans are not taxable because they have to be repaid, says Mark Misselbeck, CPA and tax director at Katz, Nannis and Solomon PC.
“So you are not ahead of the game: you have to pay back the money at some point,” he says.
Scholarships and grants used for certain expenses. The IRS maintains that you must be a student seeking a degree in a eligible educational institution and that the amounts you receive should be used for books, supplies, tuition, and fees to exclude them from your taxable income. You will have to pay taxes on the money you spend on room and board, travel and incidentals.
Resident advice on room and board. Dorm Resident Advisors, or RAs, can have long hours and a bit of drama, but the job has its perks: traditionally free room and meals. Income tax generally does not apply to these benefits.
“It’s because college requires you to live there as a condition of your job, and that benefits your employer,” says Ingram.
Education savings plans. Certain types of accounts can grow tax-free to pay for eligible educational expenses. These include series EE or series I bonds issued after 1989, 529 education savings accountsand Coverdell education savings accounts.
If you have a 529 plan, you can also withdraw up to $ 10,000 from your account tax-free to pay off eligible student loans or apprenticeship program costs. But check the fine print: each type of account has its own rules for tax-free withdrawals.[Read: Best Student Loan Consolidation and Refinance Companies.]
Is the student loan forgiveness taxable?
Student loan debt that is canceled, discharged, or canceled may be taxable. These terms are often used interchangeably to mean that you don’t have to pay off part or all of your loan, but they are not the same.
If you don’t have to pay off your loans based on your career choice, it’s called a postponement or cancellation. Loans canceled under the Department of Education’s civil service loan cancellation program, for example, are not taxable. The program forfeits your federal direct loan balance after making 120 monthly payments under a qualifying repayment plan while working full-time for an eligible employer.
On the other hand, release is when you no longer have to make payments due to circumstances such as total and permanent disability or when your school closes. If your federal student loan is canceled between January 1, 2018 and December 31, 2025, due to disability or death, it will not be considered taxable income. Unfortunately, the law is not retroactive.
If you pay off your federal or private student loan for less than the full amount, you may owe taxes on what you haven’t paid. Discuss your situation with a tax professional.
You will want to know how to pay the tax bill before you settle student loan debt, says Ingram. An exemption for insolvency, for example, could allow you to exclude settled debt from your gross income.
“Let’s say you pay $ 10,000 in taxes to get a $ 40,000 student loan canceled,” she says. “It may make perfect sense to do this. But for most people who are able to get a student loan canceled, they may not have the $ 10,000 to pay the loans. taxes. “[Read: Best Student Loans Without a Co-Signer.]
Tax breaks for student loans
Tax deductions and tax credits can help you recoup some of the money you spend on tuition and other higher education expenses.
A deduction can lower your taxable income, and a credit lowers your tax bill and can give you a refund, according to H&R Block.
Education credits include:
– American opportunity credit, which allows you to claim up to $ 2,500 per year for the first four years of study towards a diploma or similar degree.
– Lifetime learning credit, which allows you to claim up to $ 2,000 per year for tuition, college or professional fees, as well as books, supplies and equipment.
You can benefit from a tax deduction for:
– Interest paid on student loans you have taken out for yourself, your spouse or your dependent. You can deduct up to $ 2,500 for the year, depending on the amount of interest you paid and your income.