There are over 45 million student loan borrowers in the country. So as the end of the year nears and people begin preparing, it’s natural to ask, “how do student loans affect taxes?”
The good news is that student loans usually don’t have much of an impact on your taxes. They’re loans — not income — so they won’t increase your tax bill. And if you made payments, you may be eligible for a tax deduction.
Although they could help your tax liability, there are some circumstances where your student loans can negatively impact your taxes. Read on to learn more about student loans and taxes.
How can student loans affect taxes?
Student loans can affect your taxes in the following five ways:
1. You may qualify for a tax deduction
Are student loans tax deductible? While your total repayment cost isn’t deductible, the interest you pay toward your debt may be.
Whether you have federal or private student loans, you may be eligible for the student loan interest tax deduction. If you qualify, you can deduct $2,500 or the actual amount of interest you paid toward your student loans, whichever is less.
The student loan interest tax deduction is an above-the-line deduction, so you can claim it even if you don’t itemize your deductions. The deduction can reduce your taxable income, helping you save money.
Not everyone is eligible for the deduction. You can claim the full amount if your modified adjusted gross income is less than $70,000 ($140,000 if you’re married and file a joint return). If your income is between $70,000 and $85,000 ($140,000 and $170,000 for joint returns), you can claim a reduced amount. If your income is over those thresholds, you aren’t eligible for the student loan tax deduction.
You can claim the deductions as long as you meet the following requirements:
- You paid interest on a qualified loan
- You are legally obligated to repay the loan
- Your filing status isn’t married filing separately
- Your income is within the income guidelines
- Neither you nor your spouse can be claimed as dependents on someone else’s tax return
If you paid $600 or more in interest on a qualified student loan, the lender will send you a Form 1098-Student Loan Interest Statement. You can use that form to fill out your tax return.
2. If your loans are forgiven, you may have a large tax bill
Student loan forgiveness has been a hot topic. Previously, loans forgiven under certain programs, such as income-driven repayment plans, were taxable as income. If the government forgave a large amount, you could end up with a hefty tax bill.
The American Rescue Plan changed that. Thanks to the American Rescue Plan, federal loans forgiven between 2021 and 2025 aren’t taxable as income on your federal tax return. However, the same cannot be said for state tax returns.
Depending on where you live, you may have to pay state income taxes on your loan forgiveness amount. There are currently seven states that still plan on taxing loan forgiveness, but that may change in the future:
- Arkansas
- California
- Indiana
- Minnesota
- Mississippi
- North Carolina
- Wisconsin
3. Employer repayment programs are tax-exempt (for now)
The Employee Benefit Research Institute reported that 17% of employers offer student loan repayment assistance programs. These programs often function like employer-sponsored retirement plans; the company will match their employees’ student loan payments up to an annual maximum.
Thanks to federal legislation, employers can provide employees with tax-free student loan repayment benefits through 2025. Under the current legislation, employers can contribute up to $5,250 per year per employee, and the amount of assistance is not included as taxable income.
Employer student loan repayment programs aren’t currently taxable at the state level. Taking advantage of an employer student loan repayment program can be a smart way to save money and pay off your debt faster.
4. If you default on your student loans, the government can seize your tax refund
Many borrowers worry that the government will take their tax refund if they have student loan debt. However, that can only happen if you have federal loans and default on your debt.
When you default on federal student loans — meaning you didn’t make your scheduled payments for 270 days or more — the government can seize your refund through a treasury offset. It can withhold your refund and apply the money to your outstanding loan balance instead.
This doesn’t apply to private student loans.
FAQs about student loans and taxes
Below are answers to common questions about the connection between student loans and taxes.
Are student loans tax deductible?
The entire amount of your student loans isn’t tax-deductible. However, if you meet certain income guidelines, you may be able to deduct up to $2,500 in interest thanks to the student loan interest deduction.
Are private student loans eligible for the student loan interest tax deduction?
Yes, private student loans and federal student loans are both eligible for the student loan interest tax deduction.
Are scholarships and grants taxable?
In general, scholarships and grants are tax-free if they’re used to cover tuition. If you receive scholarships or grants that cover other education-related expenses, such as textbooks or room and board, the amount of the award may be taxable as income.
Can lenders take my tax refund?
The only lender who can take your tax refund is the federal government if you have defaulted on your federal student loans. If that happens, the loan servicer can take several measures, including treasury offset and seizing your refund and wage garnishment.
Planning ahead for tax season
As the year comes to a close, it’s a good idea to start thinking ahead and planning for tax season. If you have outstanding student loans, learning about the available tax deduction and other tax benefits can help you save money.
Need help preparing for tax season? Consider hiring a tax professional to help you get on track. You can use the IRS’ directory of credentialed tax preparer to find a reputable professional near you.
Learn More: Still looking to potentially save on your student loans? Learn how student loan refinancing could potentially save you money every month.
