There are a few options for deducting student loan interest and student loan payments on your federal income tax returns, including the student loan interest deduction, qualified distributions from a 529 college savings plan, employer student loan repayment assistance programs and student loan forgiveness.
Student Loan Interest Deduction
The Student Loan Interest Deduction lets borrowers deduct up to $2,500 in interest paid each year on federal and private student loans.
The interest must have been paid on a qualified education loan, which includes all federal student loans and most private student loans. Qualified education loans must have been used solely to pay for the college’s cost of attendance at a college that is eligible for Title IV federal student aid. The cost of attendance includes tuition and fees, room and board, and books, supplies and equipment, among other eligible expenses.
Mixed-use loans, such as credit card debt and home equity loans, are not eligible. Retirement plan loans and loans made to someone who is related to the taxpayer are not eligible.
The person who paid the interest must have been legally required to pay the interest. This includes payments made by the borrower and the cosigner, if any. Payments made by anybody else are treated as though they were made by the borrower.
If the borrower can be claimed as a dependent on someone else’s federal income tax return, the borrower is not eligible for the student loan interest deduction, even if that taxpayer does not claim the borrower as a dependent.
The Student Loan Interest Deduction is an above-the-line exclusion from income, so you can claim the deduction even if you don’t itemize. An above-the-line exclusion from income reduces the borrower’s adjusted gross income (AGI), potentially yielding other tax benefits.
The Student Loan Interest Deduction can be claimed for an unlimited number of years.
The income phaseouts in 2021 are $70,000 to $85,000 (single) and $140,000 to $170,000 (married filing jointly). Taxpayers who file as married filing separately are not eligible. The income phaseouts are adjusted annually for inflation.
529 College Savings Plans
The SECURE Act of 2019 added student loan repayment as a qualified expense for 529 college savings plans. Qualified distributions from 529 plans are not subject to federal income taxes or tax penalties.
A distribution to repay qualified education loans is qualified if it is used to repay student loans borrowed by the beneficiary or the beneficiary’s siblings. A 529 plan can be used to repay parent loans by changing the beneficiary to the parent.
There is a $10,000 lifetime limit per borrower for student loan repayment using a 529 plan.
The earnings portion of a 529 plan distribution to repay student loans will reduce eligibility for the student loan interest deduction.
Some states have not updated their laws to conform to the SECURE Act and may consider student loan repayment to be a non-qualified expense, subject to state income taxes and state tax penalties on the earnings portion of the distribution at the borrower’s marginal tax rate.
529 plan contributions may also be eligible for a state income tax deduction or tax credit. Most states will recapture the state income tax break attributable to a non-qualified distribution. If your state considers student loan repayment to be a qualified distribution, you may be able to make a contribution to the state’s 529 plan and then take a distribution to repay your student loans, effectively getting a state income tax break on your student loan payments.
There are no income phaseouts on this tax benefit.
Employer Student Loan Repayment Assistance Programs
About 8% of employers offer student loan repayment assistance programs (LRAP), according to the Society for Human Resource Management (SHRM).
Typically, an employer will provide employees with $100 per month to help them repay their student loans.
Normally, employer LRAPs represent taxable income to the employee. However, the CARES Act included an exclusion from income for payments of principal and interest by an employer on the employee’s student loans through December 31, 2020. (Parent education loans are not eligible. Payments of interest by the employer are not eligible for the student loan interest deduction.)
Congress might decide to extend the exclusion from income or make it permanent.
Tax-Free Student Loan Forgiveness
Normally, the cancellation of debt is treated like income to the borrower. It is as though someone gave the borrower money to repay their loans.
Certain types of student loan forgiveness and discharges are tax-free.
Generally, student loan forgiveness for working in a particular occupation is tax free if the loan forgiveness is provided by the loan program.
- Public Service Loan Forgiveness
- Teacher Loan Forgiveness
- National Health Service Corps Loan Repayment
- State loan repayment and loan forgiveness programs funded by the Public Health Service Act
- Federal Perkins Loan forgiveness programs
In addition, many types of student loan discharge are tax-free.
- Death and disability discharges of federal and private student loans are tax-free from 2018 through 2025 (inclusive)
- Closed school discharges
- False certification discharges
- Unpaid refund discharges
The cancelation of the remaining debt after 20 or 25 years of payments under an income-driven repayment plan is taxable under current law. The tax debt may, however, be waived by the IRS if the borrower is insolvent. See IRS Publication 4681 and IRS Form 982.
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