Tax Credits for Student Loans: Everything to Know

Most people who attend college in the United States use student loans to pay at least part of their tuition and education fees. While there is a reported $1.5 trillion in student loan debt, this represents millions of American adults across generations who got a great education with the help of money from the federal government or private institutions.

Since so many people in the U.S. have student loan debt, the Department of Education (DOE), the Internal Revenue Service (IRS), and other government agencies provide several approaches to handling repayment. You can set up specific payment plans, use student loan forgiveness programs, or simply use tax deductions or credits to ease your overall tax burden.

Tax Deduction vs. Tax Credit

When you use your student loans to reduce your tax burden, you have the option of a tax deduction or one of two tax credits. In general, a tax deduction reduces how much of your income is subject to taxes. For example, if you fall into the 22% tax bracket, like most people with student loans, a deduction of $1,000 will save you $220 on your bill.

A tax credit, on the other hand, reduces dollar-for-dollar how much money you owe on your taxes. For example, if you get a tax credit of $1,000, you pay $1,000 less on your taxes.

It is important to understand which of these tax options your student loans qualify for, so you can get some tax relief and pay your student loans more easily. 

The Top 3 Methods to Manage Student Loans on Your Taxes

These are the three major student loan tax credit and deduction options provided by the IRS. Student loans from both the DOE and private institutions qualify for these tax benefits.

1. Student Loan Interest Deduction (SLID): This tax deduction helps millions of college graduates all over the country by easing student loan interest. If you paid at least $600 (up to $2,500) in interest on your student loans, you can claim this money to lower the amount of your income taxed by the government. Your gross income must be $65,000 per year or below as a single filing taxpayer.
   
   You cannot claim the money you paid on the principal of your loan, which you should be paying down a little bit at a time through each monthly payment; however, you can claim the money you paid on interest on your loan once that amount surpasses $600. Loans must be qualified according to the IRS, which means:
   
   • The loan was for you (the taxpayer), your spouse, or your dependent
   • The loan was not a personal loan from a friend or relative
   • The loan was not from an employer plan
   • The loan must be used within a reasonable time frame after it is disbursed, typically within 90 days before the academic period starts and 90 days after it ends
   
   
   Your student loan must also cover specific qualified educational expenses, which, according to the IRS, are:
   
   • Tuition
   • Associated fees
   • Textbooks and related supplies
   • Equipment needed for coursework
   
   
   Educational expenses that do not qualify for the SLID, per the IRS, are:
   
   • Room and board, including on-campus housing
   • Student health fees
   • Insurance
   • Transportation
   
   
   Although you cannot use SLID to reduce your taxable income on loans that were used for living expenses or costs that were not directly related to your education, you can apply SLID to all types of student loans used for your direct education expenses. Both federal and private loan interest can be deducted from your taxes, up to $2,500 per year.
   
   You will receive a tax form 1098-E showing how much interest you paid in the past year. If you do not receive this form, or you have questions about how much interest you paid so far, contact your loan servicer directly.
   
2. American opportunity tax credit (AOTC): Like SLID, the AOTC allows you to claim up to $2,500 to ease your tax burden. Unlike SLID, however, the AOTC is a tax credit, meaning you can take up to $2,500 directly off what you owe in taxes.
   
   However, you may not have qualifying expenses in that amount; just because you spent $2,500 on your education does not mean that you can claim all of it.
   
   The qualifying educational expenses are the same as those for SLID. Money spent directly on tuition and class-related items counts, but money spent on living expenses and transportation does not count.
   
   Here is the IRS formula for this student loan tax credit:
   
   • You can claim 100% of the first $2,000 spent on qualified educational expenses, or up to $2,000 total.
   • You can claim up to 25% of the second $2,000 spent on qualified educational expenses, or up to $500 total.
   • If this student loan tax credit brings the amount you owe the government to zero, you can have up to 40% of any remaining tax credit refunded to you, or up to $1,000.
     
     There are specific qualifications that allow you to claim the AOTC:
     
   • You must be a current student pursuing a four-year degree.
   • You must attend a credentialed and recognized academic program.
   • You must be enrolled at least half time at the beginning of the academic year.
   • You must not have graduated by the beginning of the tax year (current students only).
   • You must not have claimed either the AOTC or the Hope tax credits for more than four tax years.
   • You must not have felony convictions in the tax year.
     
3. Lifetime Learning Tax Credit (LLC): Like the AOTC, the LLC is a tax credit, so you can directly take a certain amount of student loan money off your taxes. Unlike the AOTC, you can be a student in graduate school or in a professional school. You do not need to be in a specific four-year undergraduate degree program, although undergraduate students may choose the LLC rather than the AOTC.
   
   Unlike the AOTC, you can claim the LLC for an unlimited number of years while you are in school. You can start claiming it as an undergraduate and then continue claiming this credit while you attend graduate school.
   
   The LLC allows you to claim up to $2,000 that you spent on qualifying education expenses, or 20% of the first $10,000 you spend on your education. For example, if you spent $5,000 on a semester, you can claim 20% of that money for a $1,000 student loan tax credit. If you spend $20,000 on a semester, you can only claim up to $2,000 on your taxes.
   
   Like the AOTC, you must be currently enrolled in an accredited degree program, but it does not need to be a bachelor’s degree. You can claim this credit for professional development programs, medical school, or graduate programs. You must be enrolled in at least one academic period (a semester, trimester, quarter, or full year) in the tax year.

One tax deduction that is no longer available is the tuition and fees deduction. This method of managing your tax burden expired at the end of 2017, and Congress has not renewed this deduction or anything similar. If you have used this deduction in the past to lower your taxable income, note that it is not something you can claim anymore. However, you may qualify for one of the above deductions or credits to ease your student loan burden.

How to Maximize Student Loan Tax Credits and Deductions

While you can claim the SLID and either the AOTC or the LLC, you may not claim both the AOTC and the LLC, even if you qualify for both. If you are a student and make more than $12,000 in taxable income in a fiscal year, you can use one of these student loan tax credits and the tax deduction to save money. If you make less than $12,000, you may not need to file at all unless you get money back from withholdings through your employer.

To make the most of these tax options, consider what your current education plan is. For example, if you have claimed the AOTC for four years of your undergraduate education but you need a fifth year to complete your coursework, you no longer qualify for AOTC, but you do qualify for LLC. If you pay more than $600 in interest on your loans, you qualify for the SLID.

Using a combination of help on your taxes can save you the most money. While you may not save money in each individual month, you can save money every year, which leaves you in better financial standing to continue paying student loan debt down.

You should also consider how you will manage your student loans once you graduate from college. Of course, finding a good job in your career field is the primary method of paying off your student loans, but you can also look into forgiveness programs to eliminate part or all of the remainder of your loan. It is important to note that student loan forgiveness programs may leave you with more taxable income, which could mean you pay more in taxes one year. 

Loan Forgiveness, Taxable Income, and Managing Student Loan Taxes After Graduation

The Public Service Loan Forgiveness (PSLF) program is the largest student loan forgiveness program currently available through the DOE. If you work in a field that qualifies you for this program and you finally forgive your student loan debt, that debt is exchanged for tax debt. You will have a larger tax bill one year, and you will not qualify for the SLID anymore since you no longer pay interest on a loan.

There is one form of loan cancellation and forgiveness that is not considered taxable income: total and permanent disability. Per the DOE, the TPD loan elimination option is a form of student loan discharge, not forgiveness, but it does get rid of your student loans.

Unlike other forms of forgiveness, discharge, and cancellation, the TPD and death discharges do not allow your student loans to be considered taxable income once they are forgiven. You may not qualify for a student loan tax credit or deduction, but you also will not need to claim more on your taxes for the tax year.

No matter how you manage your student loans and your taxes, the federal government wants current college students and new graduates to have options for managing their student loan bills. Claiming student loan tax credits and deductions is the first step. Once you graduate, there may be other options available to help.