If you are repaying student loans, there are special tax consequences and benefits that apply to you. The following can have a significant effect on the tax bill of student loan borrowers:
- student loan interest deduction
- taxes on student loan debt that a lender forgives, and
- your filing status if you are married.
The Student Loan Interest Tax Deduction
The student loan interest deduction is a tax deduction you can claim every year when you file your taxes. It is one of the “above the line” deductions, which is usually a more valuable deduction than the “below the line” deductions that make up your itemized deduction.
You should receive a form called a 1098-E Student Loan Interest Statement from your loan servicer (the company you make payments to) every January or February. You will only receive the 1098-E if you paid more than $600 in student loan interest that tax year. If you paid less than $600, you can still claim the deduction -- just add up the interest amounts from your payment statements. Consult your tax preparer or IRS Publication 970 for instructions on how to calculate the deduction. The maximum deduction for 2013 is $2,500. (To learn more, see Tax Deductions for Student Loans.)
Taxes on Forgiven Student Loan Debt
When a creditor forgives your debt, the IRS considers the forgiven amount to be income to you. There are many exceptions to this, so check with your tax preparer for advice about your specific situation. (To learn more, see Tax Consequences When a Creditor Forgives Debt.)
If you are repaying your student loans under an income-driven repayment plan, such as the Income Contingent Repayment Plan, the Income Based Repayment Plan, or the Pay as You Earn Repayment Plan, the government will forgive any unpaid balance that remains when you are done with your repayment term. (Find out more about income driven repayment plans from Nolo’s article What's the Difference Between Income Contingent Repayment Plans and Income Based Repayment Plans?) Be prepared for a significant increase in your tax bill for the year that the balance of your student loan is forgiven. If the IRS believes you owe taxes on forgiven debt, it will send you a form called a 1099-C.
There are many exceptions to this tax effect. For example, forgiven debt does not count as taxable income in the following situations:
- Specific occupation loan forgiveness. Your debt was forgiven as part of a job-specific student loan forgiveness program, such as Public Service Loan Forgiveness or Teacher Loan Forgiveness. Find out more about these programs on the Department of Education’s website at studentaid.ed.gov or ask your loan servicer if your occupation qualifies.
- School-related loan discharges. These apply if your school closed before you could complete your program, there was fraudulent activity in your loan approval, or your school wrongly withheld a tuition refund from you. (To learn more, see Canceling Student Loans: School Closure, False Certification, Unpaid Refund.)
- Undue hardship in bankruptcy. Your student loan debt was discharged in bankruptcy because you proved "undue hardship.” See Student Loan Debt in Bankruptcy.
- Insolvency. You were insolvent immediately before the debt was cancelled. Insolvent means your assets (home equity, retirement account, etc.) are worth less than your liabilities (debts). If you think this may apply to you, consult an attorney or CPA for assistance.
Filing Status for Married Couples With Student Loans
Another significant tax issue for student loan borrowers is the choice of tax filing status for married people. Married people can file their taxes as married filing jointly or married filing separately.
Married filing separately. There can be some negative tax consequences unrelated to student loans if you file as married filing separately. On the other hand, if you are repaying your loans as part of the Income Based Repayment, Income Contingent Repayment, or Pay as You Earn programs, there are good reasons to consider filing as married filing separately. Your monthly payment under the income-driven repayment plans is set each year, and the amount is based on your income. If you file as married filing separately, then the government will only consider your income when setting the amount of your payment.
Married filing jointly. If you file as married filing jointly, the government will set your monthly student loan payment based on the combined income of both you and your spouse. To learn more, see Tax Filing Status and Student Loan Payments.