The White House just offered sweeping student loan forgiveness for millions of borrowers. Here’s what that implies when it comes to taxes.
President Biden unveiled various student loan relief initiatives, including federal loan forgiveness ranging from $10,000 to $20,000 per borrower. With over 43 million Americans carrying federal student loan debt at an average of $37,667 per borrower (excluding private loans), many will see their debt loads decrease significantly, if not completely disappear.
Will you owe taxes on the forgiven amount if your student loans are forgiven as a result of the latest announcement, the Public Service Loan Forgiveness program, or an income-driven repayment (IDR) plan? Here’s everything you need to know about student loans and taxes, as well as any extra tax breaks you might be eligible for next year.
Will you have to pay any more taxes if your student loans are forgiven?
When you receive student loan forgiveness, your forgiven debt is usually added to your taxable income when tax season rolls around. This raises the amount of taxes you owe in a particular year, either decreasing your refund or increasing your tax bill.
For example, if you earn $50,000 and have $20,000 in student loan debt forgiven, your taxable income rises to $70,000, putting you at a higher tax rate.
A clause hidden into the $1.9 trillion COVID relief package passed in March 2021, however, removes taxation on forgiven student loan debt until 2025. This implies that you will not have to pay any more taxes on your forgiven student debts.
Other tax implications for students with student loans
You may be eligible for extra tax benefits and deductions in addition to student loan forgiveness. Although the tax levels for 2023 have not yet been revealed, there are various student loan tax incentives that may increase your refund or cut your tax burden next year.
Deduction for student loan interest
When you make monthly payments on your student loans, you include both the principal and any accrued interest payments. The student loan interest deduction, whether you have private or government student loans, allows you to lower your taxable income based on how much interest you paid. This discount was increased to $2,500 per year in 2021.
You are eligible for the deduction if you paid student loan interest during the tax year and if your modified adjusted gross income (your income after qualifying taxes and deductions) was less than $70,000 (or $100,000 if married and filing jointly). Partial deductions were available for persons with MAGI between $70,000 and $85,000 ($100,000-$170,000 for joint filers).
With federal student loan repayments on hold and interest at 0%, you may not have paid any interest in the previous year. Having said that, you should log in to your student loan portal and review form 1098-E for any applicable interest payments.
If you are eligible, this deduction will reduce your taxable income, which may reduce the amount you owe the IRS or boost your tax refund. You may even be placed in a lower tax bracket, making you eligible for additional deductions and credits.
The American Opportunity Tax Credit
The American Opportunity Tax Credit is provided to first-time college students for their first four years of higher education. It lets you claim 100% of the first $2,000 in eligible education expenses, then 25% of the next $2,000 paid, for a total of up to $2,500. If you’re a parent, you can claim the AOTC for each qualifying student in your household as long as they’re designated as a dependent.
To be eligible for the full credit in 2021, your MAGI must be $80,000 or less ($160,000 or less for married couples filing jointly). You may have qualified for partial credit if your MAGI was between $80,000 and $90,000 ($160,000 to $180,000 for those filing jointly).
As a refundable credit, the AOTC may allow you to receive a tax refund or an increase to your current refund if it reduces your income tax to less than zero.
Credit for Lifetime Learning
The Lifetime Learning Credit allows you to receive money back for approved college expenses. The LLC can contribute to the cost of any level of continuing education course (undergraduate, graduate, and professional degrees). Transportation to and from college and living expenses are not qualifying expenses for the LLC.
Unlike the AOTC, there is no time limit for claiming credit. You might receive up to $2,000 each year, or 20% off your first $10,000 in eligible college expenses. The LLC, on the other hand, is not refundable, which means you can use it to reduce your tax bill if you have one, but you won’t get any of it back as a refund.
This credit was available in 2021 if you had qualifying expenses and your MAGI was less than $59,000 ($118,000 for married couples filing jointly). If your MAGI was between $59,000 and $69,000 ($118,000 and $138,000 for married couples filing jointly), you could also receive a reduced credit.
It is important to note that you cannot claim both the AOTC and the LLC for the same student in the same tax year. If you qualify for both, the AOTC usually delivers larger tax savings (and can boost your refund).
Will your tax return be garnished if your debts are in default?
Normally, if your federal student loans are in default (that is, you have been unable to pay what you owe on them for 270 days), your tax refund can be used to assist settle the total outstanding. Your federal tax refund was exempt from being garnished by the government because federal student loans were suspended during the 2022 tax year.
It’s uncertain whether this will be extended until 2023, but with the current payment pause slated to expire at the end of 2022, this advantage may be phased out.
Your tax filing status may have an effect on your student loan payments.
If you have federal student loans and are on an income-driven repayment plan, your marital status may have an impact on your payment amount. For example, if you’re married and filing jointly, your payments are based on your and your spouse’s joint income. Your payments are based only on your income if you are married and filing separately.
If you file separately to reduce your monthly IDR plan payment, you may miss out on other important tax benefits. For example, you may be unable to take advantage of the reduced tax rate available to married couples filing jointly, nor will you be able to claim the larger credit and deduction amounts available to married couples filing jointly.
The Revised Pay As You Earn, or REPAYE plan makes no distinction between married filing separately and married filing jointly. Your payments are depending on your and your spouse’s income.
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