Can Tax Return Be Taken for Student Loans
Can Tax Return Be Taken for Student Loans
One undisputed fact is that student loans have an impact on how you file your taxes even though they are not taxable. Whereas they open the door to great opportunities, once you have that diploma in your hands, the loans can become stressful. During tax season, you can explore various tips and techniques for including student loans when filing your taxes. If you happen to be in school, you may get several tax credits.
Should you file taxes on student loans?
Never file taxes on student loans because they are not considered as income. The taxman does not tax student loans since you will pay them eventually. Free money received in school is handled differently. That includes:
- Fellowship money
- Scholarship
- Fees and equipment
If you receive a nontaxable scholarship, you do not have to report it during your tax return. However, any portion of the mentioned funds that go into research travel, room, and board, or optional equipment is taxable. That should be reported under gross income.
Getting Student Loan Interest Deduction
The student loan interest deduction is a federal income tax deduction that you can use to subtract as much as $2,500 of the payable interest on a qualified student loan from the taxable income. It is one of the numerous tax breaks that students and parents can use to pay for education costs.
Similar to most tax deductions, you can rely on student loan deductions to cut back on the year’s taxable income. For instance, those within the 22% tax bracket and qualify for a $2,500 deduction get to reduce their federal income tax by $550.
However, student loan interest deduction differs from other deductions in that it classifies as an adjustment to income on IRS Form 1040. For that reason, you can claim it without filling Schedule A that is normally used for itemizing deductions.
You have to meet certain requirements before you can get this deduction. For starters, the student loan must have been obtained for the taxpayer, the taxpayer’s dependents, or the taxpayer’s spouse. In a situation where the student is the legal borrower, a parent who repays the loan does not qualify for this reduction.
Also, the student loan in question must have been applied when the student was enrolled in a college program that led to the attainment of the recognized credentials. Furthermore, it must have been used for what qualifies as a higher education expense, including fees, tuition, supplies, textbooks, equipment, and supplies required for coursework.
The following do not qualify as higher education expense applicable for student loan interest deduction:
- Insurance
- Health fees
- Transportation
You must remember that the student loan interest break is not the only federal tax break that students and parents can explore. You may consider looking into federal tax credits for higher education.
Student Loans and Tax Refund
When you default your student loans, you can encounter something called tax refund garnish. The term refers to a situation where you get a tax offset, that is, all your tax refund gets taken away due to your student loan being in default.
Two factors come into play when tax refund offset happens:
- Your student loan is a Federal loan
- You are currently in default
Merely having a student loan does not mean tax refund garnish will happen. If you get tired of tax refund garnishing, you should take the right measures to remove the loan from default.
Student Loan Forgiveness and Taxes
If you received a student loan forgiveness, you may still owe taxes on the total amount forgiven depending on the repayment plan followed. The amount forgiven classifies as income and is subject to taxes which you are required to clear.
The taxes can easily run into thousands of dollars as determined by the amount of student loan forgiven. Most people often sweat on the need to pay taxes over forgiven amount. However, that should not concern you much. The best approach is to adopt a desired repayment plan and pursue the desired forgiveness path.
Also, keep in mind that federal student loan forgiveness does not incur taxes. These include plans such as teach loan forgiveness, National Health Service Corps Loan Repayment Program, law school loan repayment assistance programs, and teacher loan forgiveness.
Important Tips for Students or First-Time Tax Filers
The tax time can be exhausting. When dealing with student loans during tax time, consider the following essential factors:
- Dependents do not qualify for interest deduction
If your parent enlists you as a dependent, you are not qualified for a student loan interest deduction from your overall payable tax. On the other hand, your parent does qualify for a deduction if they are the borrower of the student loan. In a situation where someone else assists you in paying the student loan and does not list you as a dependent, you could qualify for the interest deduction.
- Explore existing tax credits
Even though those who are yet to finish their college education are not required to start servicing the student loan, that does not block you from using your student status during tax time. The two main types of tax breaks that you can use while still in school are:
- The American Opportunity Credit
- The Lifetime Learning Credit
- Try to keep off default as much as you can
Defaulting your student loan negatively affects your credit and leads to additional costs, among other potential consequences. It may diminish your wages and the tax refund withheld. You risk your tax refund by defaulting your student loan and may make it hard to create a repayment plan or forgiveness program.
- Do not fear the marriage penalty
Marriage penalty refers to the total tax bill that a couple faces for jointly filing their taxes. It often leads to higher taxes as opposed to when the couple filed their taxes separately. However, when it comes to student loan deductions, a couple that files their taxes separately may not qualify for student loan interest deduction.
- Avoid using 529 funds when paying your student loan
The U.S. Securities and Exchange Commission explains that 529 funds can be used without incurring tax expenses. For instance, you can use them to cater for educational expenses. However, when you use the funds for loan repayment, be ready to face a 10 percent penalty and classification of the amount as taxable income.