Student Loans and Taxes: The Ultimate Guide

Written by: Kristyn Pilgrim
Updated: 1/29/20

Student loans from both the Department of Education (DOE) and private institutions are important ways that college students get financial help to complete their degree. Unlike scholarships or grants, student loans accrue interest and require repayment.

In the case of direct unsubsidized loans and private loans, repayment begins immediately. Direct subsidized loans do not require monthly payments until after you graduate.

Since student loans cover most aspects of going to school, including rent or on-campus housing, food, and bills, you may wonder if this money is considered income. And if it is considered income, how do tax laws affect it?

There are several ways that your student loans and your taxes impact each other. We’ll break down how to manage educational debt, from your first year of college to your final student loan payment.

Why Filing Student Loan Money on Your Taxes Is Important

As a current or recently graduated student, you are considered an adult with new responsibilities, including taxes.

While many undergraduates are still claimed as dependents by their parents on tax forms, many others are independent and living on their own with jobs they must file taxes for. Once you graduate from college and begin seeking employment, you will also need to learn about how to file taxes, including what deductions you qualify for.

A portion of your monthly income goes toward paying down student loans, and this expense is a boon for your tax returns. 

What Is the Student Loan Tax Deduction?

The most important way your student loans and taxes intersect is with the student loan tax deduction. If you took out any student loans for yourself, your dependent child, or your spouse, you can claim a deduction on your taxes for the interest you pay on the loan, regardless of whether the loan was from the federal government or a private institution. The maximum deduction is up to $2,500 per year.

The basic qualifications for this deduction are: 

  • You paid interest on a student loan in the past year
  • You are legally obligated to pay the interest on this loan
  • You are not a married person filing separately from your spouse
  • You and your spouse file together and are not someone else’s dependents
  • Married couples’ modified adjusted gross income must be less than $165,000
  • You are a single filer with an income below $65,000 or a modified adjusted gross income of less than $80,000

Benefits of the Student Loan Deduction

There are several benefits to the student loan tax deduction. First and foremost, all student loan interest qualifies you for this tax deduction. If you took out one direct subsidized loan, your interest qualifies you. If you took out several private loans from banks, that interest still qualifies.

Next, you do not need to itemize your tax deductions to claim this benefit. If you claim the standard tax deduction on your taxes, you can still claim your student loans on your taxes.

If you paid more than $600 in just the interest on your loan in the past year, the Internal Revenue Service (IRS) will send you a 1098-E form, which shows how much you paid in the past 12 months. When you file your taxes, you can fill out the information provided to you through this form.

You can claim any interest you accrue, of course, but if it is less than $600, you may need to contact your student loan servicer directly to ask for information on how much money you paid specifically in loan interest. You could also access your records online, especially through the DOE’s website. 

How Taxes Work With Multiple Loans

You may have more than one student loan, including a combination of federal and private loans. In this case, you will receive more than one Form 1098-E if you paid more than $600 in interest on multiple loans. However, you will not receive this form if you paid more than $600 in interest total, but that amount was spread across multiple loans.

For example, if you paid $300 in interest on a private loan, $200 on a direct unsubsidized loan, and $150 on a direct subsidized loan, you will not receive a Form 1098-E. However, you can still claim all this interest on your taxes without itemizing it. You simply list the total you paid.

In rare cases, you may pay more than $2,500 on just interest on your student loans. If this is the case, you cannot claim anything over $2,500, as this will reduce the amount of money you owe to the IRS or increase the amount of money you receive on your tax return. 

Who Can Claim Student Loan Tax Deductions?

The student loan tax deduction is technically an income adjustment. As long as you pay interest on your student loans, you can claim these payments as tax deductions.

As a current student, you can also claim the interest as a tax deduction on your annual taxes, or your parents can claim interest payments if you are a dependent student and they took out a loan for you, like the parent PLUS loan.

Requirements for current students include

  • You must be enrolled at least half time in a degree program with a college, university, or professional school
  • The loan must cover qualifying educational expenses, like tuition, books, and supplies
  • The person filing taxes must be the person who took out the loan, a person who can claim you as a dependent on their taxes, or your spouse

Keep in mind that the AOTC only covers four years of an undergraduate degree. If you or your dependent student spend more than four years earning a bachelor’s degree, you cannot claim this tax credit in your fifth year at school.

American Opportunity Tax Credit

While qualifying students or their parents can claim the student loan tax deduction, you could also qualify for other tax credits, like the American Opportunity Tax Credit (AOTC). This tax credit covers qualified educational expenses, whether you paid these with scholarships, personal income, college savings account money, or student loans.

You can claim up to $2,500 per student (yourself or your dependent child), but the IRS breaks this money up in two ways:

  • You can claim 100% of the first $2,000 you spend on educational expenses
  • You can claim 25% of the second $2,000 you spend on educational expenses

If you spend less than $2,000 on qualified expenses for your or your child’s education, you can claim all of that money on your taxes. If you spent more than $2,000 but less than $4,000, you can only claim 25% of that amount.

The AOTC may reduce your tax bill to zero. If you owe nothing to the IRS after claiming the AOTC, you can continue to claim student loan tax credits or other qualifying tax credits, and you can get up to 40% of that money or up to $1,000 (whichever is less). For some students or their parents, this is an important tax refund.

It is important to note that qualifying educational expenses for the AOTC are more limited than those for the student loan tax deduction. These expenses include:

  • Tuition
  • Books
  • Other supplies (e.g., laptop)

They do not include:

  • On- or off-campus housing
  • Food
  • Transportation

To qualify to claim the AOTC, you must:

  • Be pursuing an undergraduate degree or other recognized educational credit
  • Be an enrolled student at least half time at the beginning of the tax year
  • Have a single filer adjusted gross income of less than $80,000
  • Have an adjusted gross income of less than $165,000 if you file jointly with a spouse
  • Not have finished your four-year education (only undergraduate students qualify for AOTC)
  • Not have claimed the AOTC or a former Hope credit for more than four years
  • Not have a felony conviction at the end of the tax year

If you qualify, the IRS will send you or your parents a Form 1098-T, Tuition Statement. You should receive this tax document from your school by Jan. 31. As you file your taxes, complete Form 8863 and attach it to Form 1040.

Lifetime Learning Credit

The AOTC is only for undergraduate, four-year students. It can only be claimed as a tax credit while the student attends four years of university. For students who spend more than four years getting a higher education, the Lifetime Learning Credit (LLC) is a great option for reducing your tax burden.

Like the AOTC, the LLC covers qualified tuition and related expenses (books and supplies, but not rent or transportation). It also covers far more educational options than the AOTC.

The LLC can cover up to 20% of the first $10,000 of tuition you pay for: 

  • Undergraduate education at a four-year college
  • Graduate education at a college or university
  • Professional degree courses
  • Continuing education to improve or acquire job skills

In practical terms, the LLC lets you claim up to $2,000 on your taxes. To claim the LLC, you (or your dependent) must:

  • Have qualifying educational expenses, even if they were paid with student loans
  • Be enrolled in an eligible educational institution
  • Make less than $67,000 as a single filer
  • Make less than $134,000 if filing with a spouse

To claim this credit, your school will send a Form 1098-T, Tuition Statement, by Jan. 31. You will use the information on this form to fill out Form 8863 and attach it to your completed Form 1040.

Unlike the AOTC, you can use the LLC to claim money off your taxes until you pay nothing, but you will not receive anything beyond that back as a tax refund.

Student Loan Forgiveness Impacts Your Taxes

The above-listed tax credits are important tools to manage your finances while you are in school, after you have graduated, or if you are a parent with a dependent child attending college. By adjusting your income during tax season, you reduce your tax burden or increase the amount of money you get back from the IRS. This can help you continue paying off the principal on your private or federal student loans.

There are some cases when student loans and taxes collide and increase your tax burden. Student loan forgiveness programs are one of many methods to cancel debts. When you have a large amount of money (like a student loan debt) canceled, the IRS considers this taxable income. You must report it on that year’s tax forms.

To file taxes on canceled student loan debt:

  • Fill out Form 1099-C, Cancellation of Debt
  • Complete information on how much money was canceled and when the cancellation occurred
  • Contact your former loan servicer or educational institution for information if you are unsure about specific issues

There are some exceptions to canceled or forgiven student loan debt. For example, if you work for a certain period of time in a certain profession, you might qualify to not pay income tax on canceled or forgiven student loan debt. These professionals are typically volunteers or involved in health services in needy areas.

While many forms of forgiveness, cancellation, and discharge lead to taxable income requirements for your student loan debt, one important change to these rules was put in place in 2018. If you qualify for total and permanent disability discharge of your student loan debt because you have a disability that prevents you from maintaining any form of employment, your forgiven debt will no longer be considered taxable income.

Similarly, if you were paying student loans for a spouse or dependent who died, you qualify for death student loan discharge. That is also no longer considered taxable income.

This can help borrowers who incur such high personal expenses (from medical bills, funeral expenses, and other related issues) that they cannot take on the additional tax burden.

Student Loans and Taxes Can Work Together for Your Benefit

Although you may feel intimidated by the thought of student loans, taxes, or both, you can benefit from making student loan payments to both federal or private student loans when you file specific financial information on your taxes.

Any interest payment you make can reduce your tax burden. You can then use your tax refund to make a larger payment on a federal student loan, without penalty, so you can eliminate your debt faster.