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Here are three ways student loans can affect your taxes — and how you can avoid paying more.
You could deduct up to $2,500 in student loan interest payments on your income taxes each year. Say you have a $60,000 salary. You would pay taxes as if you made $57,500 after the deduction.
How much you can deduct depends on a few factors:
Your servicer should send you a form in January telling you how much interest you’ve paid during the previous tax year and how much you’re eligible to deduct.
How to calculate your student loan tax deduction
If you’re married but file taxes separately, you can’t qualify for the student loan interest deduction. You also can’t get the deduction if someone claims you as a dependent on their taxes. In that case, the person who claims you as a dependent can deduct your student loan interest payments from their taxes.
The IRS generally considers any canceled debt to be taxable income, including some types of student loan forgiveness. This mainly applies to:
Depending on your income and the amount forgiven, this could send you into a higher tax bracket. This means you’ll also pay taxes on a higher percentage of your income.
The IRS generally doesn’t consider debt forgiveness in exchange for working a particular job or for a specific employer to be taxable income. Forgiveness through programs that require healthcare providers to work in a specific geographical area are also exempt.
Some popular forgiveness programs that aren’t taxed include:
You also don’t have to pay taxes if you qualify for total and permanent disability discharge. And loans forgiven due to the death of the borrower aren’t taxable either.
The government can garnish your tax refund if you default on your student loans — meaning you won’t receive a tax refund for that year. Your federal loans go into default after 270 days of nonpayment. Private loans often go into default earlier, sometimes as soon as 60 to 90 days after you miss a repayment.
If the government is going to garnish your tax refund, you should receive a tax offset letter that explains how much it’s withholding and who to call if you have questions. You could get the tax offset canceled if you’re facing financial hardship or going through bankruptcy proceedings.
How to avoid a student loan tax offset
The way you file your taxes can also affect how much you pay for federal student loans if you’re on an income-driven repayment plan. With some plans, filing jointly as a married couple means the Department of Education will consider both your and your spouse’s incomes when calculating your monthly repayments.
But before you decide to file separately, consider the drawbacks first. You won’t be eligible for the student loan interest tax deduction, you’ll likely pay a higher tax rate and you might not be eligible for as many claims or tax credits. Make sure the difference in income-driven repayments is worth it before you make a decision.
The student loan interest tax deduction is the main way student loans affect taxes for most borrowers. But if you’re considering forgiveness or default on your loan, it could end up costing you more. Married couples should also pay attention to how their tax filing status affect their student loan repayments and ability to take deductions.
You can learn more about how it all works by checking out our guide to student loans.
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