Many students borrow money or accept grants and scholarships to help pay for higher education. Luckily, you don’t report student loans as income on your tax return, and you don’t have to pay taxes on certain types of financial aid.
But settled or canceled student loan debt is typically taxable.
If the IRS counts money you received for school as taxable income, that “directly impacts your taxes,” says Kristin Ingram, certified public accountant, clinical instructor of accounting at the University of Hartford and owner of accounting education website Accounting in Focus. “The more taxable income you have, the higher your taxes will be.”
Taxable income is your total income after subtracting deductions and exemptions for the tax year.
If you’re using several ways to pay for school, you may be confused about what is taxable and worried that you could end up with a big tax bill. Here’s what you need to know about how student loans can affect your taxes, as well as tax benefits that could reduce your burden.
[Read: Best Private Student Loans.]
Are Student Loans Considered Income?
Uncle Sam does not tax either federal or private student loans as income. But you could have to pay taxes on:
Portions of scholarships and grants. You will need to pay taxes on scholarships used for anything other than tuition payments, books and supplies. If you received a $15,000 scholarship and spent $12,000 on tuition but the rest on room and board, then you would owe taxes on the $3,000 difference.
You’ll also get a tax bill on payments you receive for teaching or research required for scholarships or grants.
Employer-provided tuition assistance programs. Some employers provide tuition reimbursement or student loan repayment to attract talent. The downside of these programs is that contributions to employees may be taxable.
You will pay taxes on any amount more than $5,250 toward your education in a year, and your employer should report the taxable portion on your W-2 form.
Student-athlete stipends. As with scholarships and grants, these stipends are taxed when they are used toward room and board or incidentals.
Federal work-study programs. Whether you receive a salary or hourly pay as an undergraduate or graduate student, your work-study income is taxable. Your school will give you a W-2 form with all of the information you need to report your wages.
What Type of Financial Aid Is Not Taxable?
You won’t need to pay taxes on these types of financial assistance for school:
Student loans. Private and federal student loans are not taxable because they have to be repaid, says Mark Misselbeck, CPA and tax principal at Katz, Nannis and Solomon PC.
“So you’re not ahead of the game: You have to pay back the money at some point,” he says.
Scholarships and grants used for certain expenses. The IRS maintains that you must be a degree-seeking student at an eligible educational institution and that the amounts you receive must be used for books, supplies, and tuition and fees to exclude them from your taxable income. You’ll need to pay taxes on the money you spend on room and board, travel and incidentals.
Resident adviser room and board. Dorm resident advisers, or RAs, may have long hours and a little drama, but the job has perks: traditionally, free room and board. Income tax generally doesn’t apply to these benefits.
“That’s because you’re required by the university to live there as a condition of your employment, and it benefits your employer,” Ingram says.
College savings plans. Certain types of accounts can grow tax-free to pay for qualified education expenses. These include Series EE or Series I bonds issued after 1989, 529 college savings accounts, and Coverdell education savings accounts.
If you have a 529 plan, you can also withdraw up to $10,000 from your account tax-free to repay qualified student loans or apprenticeship program costs. But check the fine print: Each kind of account has its own rules for tax-free withdrawals.
Is Student Loan Forgiveness Taxable?
Student loan debt that is canceled, discharged or forgiven may be taxable. These terms are often used interchangeably to mean that you don’t have to pay some or all of your loan, but they are not the same.
If you don’t have to pay your loans based on your choice of career, this is called forgiveness or cancellation. Loans forgiven under the Department of Education’s Public Service Loan Forgiveness program, for example, are not taxable. The program forgives the balance on your federal direct loans after you make 120 monthly payments under a qualifying repayment plan while working full time for an eligible employer.
On the other hand, discharge is when you no longer have to make payments because of circumstances such as a total and permanent disability or when your school closes. If your federal student loan is discharged between Jan. 1, 2018, and Dec. 31, 2025, because of disability or death, it won’t be counted as taxable income. Unfortunately, the law is not retroactive.
If you settle your federal or private student loan for less than the full amount, you may owe taxes on what you didn’t pay. Talk with a tax professional about your circumstances.
You’ll want to figure out how to foot the tax bill before you settle student loan debt, Ingram says. An exemption for insolvency, for instance, could allow you to exclude the settled debt from your gross income.
“Let’s say you pay $10,000 in taxes to have a $40,000 student loan forgiven,” she says. “It can totally make sense to do that. But for most people who are in a position to have a student loan forgiven, they might not have the $10,000 to pay the taxes.”
Tax Breaks for Student Loans
Tax deductions and credits can help you get back some of the money you spend on tuition and other higher education expenses.
A deduction can drop your taxable income, and a credit reduces your tax bill and can give you a refund, according to H&R Block.
Education credits include the:
— American Opportunity Credit, which allows you to claim up to $2,500 per year for the first four years of school toward a degree or similar credential.
— Lifetime Learning Credit, which allows you to claim up to $2,000 per year for any college or career school tuition and fees, as well as for books, supplies and equipment.
You can take a tax deduction for:
— Interest paid on student loans you took for yourself, your spouse or your dependent. You can deduct up to $2,500 for the year, depending on how much interest you paid and your income.
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