How Student Loan Debt Can Hit Your Tax Returns
April 15th is a day most are familiar with. For some, it means sending money off to Uncle Sam. For others, it means an influx of cash as a tax refund is issued.
Tax season with student loans can be a little different since student loans could impact your tax return in a couple different ways. In some cases, certain tax deductions can help borrowers decrease their tax liability (which is the technical term for how much an individual owes in taxes). Other times, the harsh consequences of struggling to make student loan payments kick in.
Taxes and student loans can be confusing enough on their own. When you combine them, it can feel like you are trying to navigate a maze. While everyone’s situation is different, there are some rules and regulations worth knowing.
Consulting with a tax professional can provide clarity on the specific tax questions you might run into—this article is meant to be a very high-level overview, only.
Student Loan Debt and Tax Returns
While there are a variety of different types of student loans with different requirements and terms, generally student loans aren’t taxed as income. That’s true of most other loans, too, since they are generally considered debt by the IRS.
If an individual’s federal student loans are forgiven, in some cases, the amount forgiven can be considered taxable income. There are a few different options for federal student loan forgiveness and they all have different requirements. Generally, the borrower must qualify for the program, fulfill the requirements (like making a minimum amount of payments), and then apply for forgiveness.
If the application is approved, the remaining loan balance will be forgiven. Whether or not the forgiven balance is considered taxable income will depend on the type of forgiveness the borrower receives. For example, balances forgiven under the Public Service Loan Forgiveness (PSLF) program are not taxed .
Student Loan Tax Deduction
Repaying student loans can be dreary work—requiring years of faithful payments before the loans have been repaid. But there is one small tax-related bright spot that could potentially boost borrowers’ tax refunds in certain situations. It’s the student loan interest deduction, which allows individuals to claim the money they paid in interest on their student loans during the year on their taxes.
Generally, loan servicers distribute a 1098-E form to borrowers by either mail or online (depending on borrower preferences). This form totals the interest paid by the borrower in the previous calendar year.
The maximum deduction for the 2018 tax year is $2,500 and in order to qualify for this deduction, there are income restrictions. For those filing single, a modified adjusted gross income under $65,000 could allow them to qualify for the full benefit. For those filing jointly, the limit is $130,000.
The benefit is phased out for single filers making between $65,000 and $80,000. For those filing jointly, it’s phased out between $130,000 and $160,000. Those making over $80,000 as single filers, or over $160,000 filing jointly, won’t be able to deduct student loan interest on their taxes. Those who are married but filing separately also won’t qualify for this deduction.
Qualifying for the student loan interest deduction could afford borrowers up to $2,500 in deductions, which could brighten anyone’s spring. If dialing in on your debt is one of your financial priorities, your tax refund could be one way to help you accelerate your student loan repayment.
Making a lump sum payment toward student loan debt won’t be for everyone, for instance, if you are working toward PSLF. For those that also have other higher interest debt, a tax refund could be used toward that instead.
Defaulted Federal Student Loans and Tax Returns
For families and individuals that are strapped for cash, a tax refund can be a vital boost to their income. But for those in default on their student loans, there’s no guarantee that a tax refund will arrive. The federal government has the power to seize tax refunds as a way to collect on outstanding debts, which included federal student loans.
The tax refund may then be applied to the defaulted loan, called a Treasury offset. This is happening with increasing frequency, as student loan debt continues to grow and the number of borrowers in default on student loans increases.
According to CNBC , nearly $3.3 billion has been collected by the federal government from 1.4 million student loan borrowers’ federal tax refunds this year alone. This is up from 2016 numbers that indicate $2.3 billion was collected from 1.2 million borrowers.
For borrowers who are already struggling to make ends meet, losing the tax refund can be a serious blow. The IRS is required to notify individuals before taking action, but for a variety of reasons borrowers don’t always see it. For example, people may have moved and have not provided a forwarding address. Or perhaps someone is distressed and they ignore the notice.
Those who’ve had their tax refunds seized can request that the Department of Education review their case in hopes of having it returned. But this process can be difficult. In order to have their refunds returned, borrowers are required to prove extreme hardship—generally this means they are facing eviction or foreclosure.
Seized tax returns are just one consequence of defaulted federal student loans. In addition, borrowers in default could have their wages garnished, be taken to court, have the full balance of their federal student loans become due immediately, or more.
Dealing with Student Loan Default
There are resources and programs available to borrowers who are having issues repaying their federal student loans and for those who may already be in default. To get out of default, federal student loans can generally be consolidated, rehabilitated, or paid in full.
Borrowers in default could consolidate their federal student loans into a new Direct Consolidation Loan . To consolidate, borrowers typically either have to agree to make payments on an income-driven repayment plan, or “make three consecutive, voluntary, on-time, full monthly payments on the defaulted loan” before it can be consolidated, according to the Department of Education.
Another option may be to rehabilitate the loan. The process can vary slightly by loan type, but generally the borrower will work with the loan servicer. In the case of Direct Loans and FFEL Loans, the borrower must agree in writing to make “nine voluntary, reasonable, and affordable monthly payments” within 20 days of the due date. Those nine payments must be made “during a period of 10 consecutive months .”
The third option is to pay the defaulted loan in full, which generally isn’t a realistic option for most people.
For borrowers currently struggling to make payments, it could be worth taking action before the loan falls into default. Borrowers with federal student loans could consider switching to an income-driven repayment plan, which sets the monthly payment at a percentage of the borrower’s discretionary income.
This could lead to a more manageable monthly payment. Keep in mind that this also could stretch out payments over a longer period of time, which likely means paying more interest over the life of the loan.
What About Student Loan Refinancing?
For some borrowers, student loan refinancing could be worth considering. It won’t be right for everyone, but for those that qualify, it could give an option to extend their loan term, which could lead to lower monthly payments.
Both income-driven repayment plans and refinancing with a longer term could lead to paying more interest over the life of the loan, but they could also make monthly payments more manageable. It’s also important to note that refinancing with a private lender eliminates eligibility for federal repayment plans and benefits like deferment.
Borrowers with a strong credit history (among other financial factors) could potentially qualify for a lower interest rate through refinancing. When you refinance with SoFi there are no fees, and you could qualify for unemployment protection in the event you unexpectedly lose your job through no fault of your own.
SoFi Student Loan Refinance
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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