What’s more stressful than student loans and taxes? Not much. But don’t get paralyzed. Here are some tips to guide you as we enter the height of tax season.
Student Loan Interest Is Still Tax Deductible
For many years, the tax code permitted many borrowers to claim a portion of their student loan interest paid as a deduction on their tax return. This deduction was threatened during the congressional battle over the tax bill last year. However, the final version of the tax bill preserved this tax deduction. So if you received a 1098-E statement issued by your student loan lender (which would show the amount of interest that you paid during 2017), you may still be able to claim some of that as a deduction. Remember that the deduction is capped, however, and is also phased out for higher income earners.
Certain Student Loan Discharges Are Now Tax-Free
Federal student loans can be discharged if the borrower dies or becomes totally and permanently disabled. For years, these discharges were taxable events – meaning that the cancelled loan balance could be treated as income for the borrower. However, the recently-passed tax bill eliminated the taxable nature of these student loan discharges – meaning they are now tax-free events as of January 1, 2018.
Lower Your AGI
If you’re on an income-driven repayment plan (such as IBR, PAYE, or REPAYE), your monthly payments are likely based on your Adjusted Gross Income (AGI), the taxable income as reported on your federal tax return – the Form 1040. Your AGI can be reduced by certain pre-tax deductions such as contributions to certain retirement accounts or Health Spending Accounts (HSA’s). This may be smart financial planning generally, and it can also lower your income-driven student loan payments when you next re-certify for your plan.
If You’re Married, Consider Tax Filing Status
If you’re married, and one or both of you have federal student loans, you’ll want to consider your tax filing status. Under three of the income-driven repayment plans for federal student loan borrowers (the Income-Contingent Repayment (ICR) plan, the Income-Based Repayment (IBR) plan, and the Pay As You Earn (PAYE) plan), your federal loan servicer will consider your joint income with your spouse only if you file joint tax returns. However, under the Revised Pay As You Earn (REPAYE) plan, your federal loan servicer will consider your spouse’s income regardless of how you file your taxes. REPAYE uses a cheaper repayment plan formula as compared to ICR and IBR, but it may actually result in higher payments for some married couples who have been repaying their loans under ICR, IBR and PAYE while filing taxes separately. At the same time, however, filing taxes as married-filing-separately could result in higher overall taxes for the household. If those higher taxes offset the lower student loan payments, it could wipe out any savings.
Traps For Defaulted Borrowers
If you’re in default on your federal student loans, you may have been referred to a program that allows the IRS to seize your federal tax refund and apply it to your defaulted federal student loan. If you are expecting a tax refund, you may want to resolve your student loan defaults first. The good news is you can work with a tax advisor to request an extension of time to file your taxes – that way you can resolve your defaults, and hopefully still collect your tax refund.
Student Loan Settlements
If you got a portion of your student debt cancelled in 2017 following a negotiated settlement, your former lender may send you a Form 1099-C, requiring that you report the portion of your loan balance that was forgiven as “income” for tax purposes. This might mean you’ll owe more in taxes than you originally thought. However, there are some ways of avoiding or reducing this tax — for example, if you were insolvent at the time that the debt was canceled (meaning your total debts exceeded your total assets).
Talk to a Qualified Tax Professional
Tax issues can be challenging and complicated, and you don’t want to make a mistake and get on the wrong side of the IRS. Talk to a Certified Public Accountant or other qualified tax professional to get your tax questions answered and make the most of your options.
This article is part of the Student Loan Debt Movement, which is encouraging and inspiring people to take action on their student loans.