Do I Have to Pay Taxes on Student Loans?
Unravel the complex tax implications of student loans. Gain clarity on how various stages of your loan impact your tax responsibilities and benefits.
Student loans play a significant role in financing higher education for many individuals across the United States. Understanding the tax implications associated with these loans is a common concern, encompassing various stages from receiving the funds to potential loan forgiveness or interest deductions. Navigating these tax considerations can help borrowers make informed financial decisions.
Receiving Student Loan Funds
Money obtained through student loans, whether from federal or private sources, is not considered taxable income when received. A student loan represents a debt that must be repaid, distinguishing it from earned income or gifts. This principle applies irrespective of how the funds are used, whether for tuition, fees, books, or living expenses.
The non-taxable nature of student loan proceeds holds true for both the primary borrower and any cosigner. Since the funds are a temporary advance that will be repaid with interest, they do not increase a person’s net worth in a way that would trigger a tax liability at the time of receipt. This characteristic helps ensure students and their families can access necessary educational financing without immediate tax burdens.
Taxability of Student Loan Forgiveness
When a debt is canceled or forgiven, the Internal Revenue Service (IRS) considers the forgiven amount as taxable income, as it represents a financial benefit that no longer requires repayment. Lenders issue Form 1099-C, “Cancellation of Debt,” to the borrower and the IRS, reporting any debt amount of $600 or more that has been forgiven. Without specific exceptions, a forgiven student loan could result in a significant tax bill for the recipient.
There are, however, several important exceptions where forgiven student loans are not subject to federal income tax. One significant exception is for loans forgiven under the Public Service Loan Forgiveness (PSLF) program. PSLF provides tax-free forgiveness for the remaining balance on federal direct loans after 120 qualifying monthly payments while working full-time for a qualifying employer.
Discharges due to the borrower’s death or total and permanent disability (TPD) are not considered taxable income. Federal student loans discharged because of the borrower’s death or TPD are exempt from federal income tax.
Another non-taxable scenario involves the insolvency exclusion. If a borrower is insolvent, meaning their total liabilities exceed the fair market value of their assets immediately before the debt is canceled, some or all of the forgiven debt may be excluded from taxable income. Borrowers claiming this exclusion file Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness.”
Forgiveness related to closed school discharges or false certification discharges is not taxable. If a school closes while a student is enrolled, or if a student’s eligibility was falsely certified by the school, any discharged loans are not considered taxable income.
A temporary federal exclusion was established by the American Rescue Plan Act (ARPA) of 2021. This legislation made nearly all student loan forgiveness tax-free at the federal level for discharges occurring between December 31, 2020, and January 1, 2026. This temporary provision covers various types of forgiveness, including balances forgiven under income-driven repayment plans, which would otherwise be taxable after the repayment period. After December 31, 2025, unless extended by new legislation, forgiveness under income-driven repayment plans will revert to being taxable at the federal level.
Deducting Student Loan Interest
Eligible taxpayers may deduct a portion of the interest paid on qualified student loans, which can reduce their taxable income. This student loan interest deduction is an “above-the-line” deduction, meaning it reduces a taxpayer’s adjusted gross income (AGI) regardless of whether they itemize deductions on their tax return. The maximum amount that can be deducted is $2,500 annually, or the amount of interest actually paid, whichever is less.
To qualify for this deduction, several requirements must be met. The loan must be a qualified student loan, meaning it was taken out solely to pay for qualified higher education expenses. These expenses include tuition, fees, room and board, books, supplies, equipment, and other necessary costs of attendance. The student must have been enrolled at least half-time in a degree program or other recognized educational credential.
The borrower must be legally obligated to pay the interest on the loan. The taxpayer cannot be claimed as a dependent on someone else’s tax return. The deduction is also subject to income limitations based on the taxpayer’s Modified Adjusted Gross Income (MAGI). For the 2024 tax year, the deduction begins to phase out for single filers with a MAGI exceeding $80,000 and is completely eliminated at $95,000. For those married filing jointly, the phase-out begins at $165,000 and is completely eliminated at $195,000.
Lenders are required to send Form 1098-E, “Student Loan Interest Statement,” to borrowers if they paid $600 or more in student loan interest during the year. Even if less than $600 was paid, borrowers can still claim the deduction by obtaining the exact amount from their loan servicer. The deduction is claimed on Schedule 1 of Form 1040.