Gone are the days when a part-time job could cover the cost of college. The average tuition costs for a four-year public school in 1977 totaled only $2,600 (adjusted for inflation), according to College Board. For the 2016-17 school year, those costs add up to an average of $9,650.
It’s common for college students to use student loans to help pay for their education. In fact, there are 44.2 million Americans with student loan debt. But what does that debt mean for you at tax time?
If you’ve applied for student loans and are receiving disbursements, you might be wondering: Do student loans count as income?
Are student loans considered income?
“Student loans are not considered taxable income because it is expected that you’ll pay that money back at some point,” said Josh Zimmelman, the owner of Westwood Tax & Consulting.
When you borrow money to pay for school, you don’t need to report your loan amounts as income on your tax return. It might feel like you should because you’re receiving money, but those funds aren’t truly yours. It’s borrowed money that you have to pay back with interest.
Rather than counting as income on your taxes, Zimmelman pointed out, student loans can actually provide some tax benefits.
“There are tax credits for higher education expenses,” said Zimmelman. Even if you pay for your schooling with student loans, it’s possible to claim tax credits with options such as the American Opportunity Credit or the Lifetime Learning Credit. The advantage of tax credits is that they directly lower the amount of tax you owe.
The American Opportunity Credit can result in up to $2,500 per year in tax credits for your first four years of college. The Lifetime Learning Credit allows you to claim up to $2,000 a year.
Once you start repaying your student loans, you can still get a tax break because the interest you pay is tax deductible. The student loan interest tax deduction allows you to reduce your taxable income by up to $2,500 a year, lowering your total tax bill. You can even see how much you could save using this deduction with this student loan interest deduction calculator.
What about scholarships and grants?
You don’t have to claim student loan money as income since you have to pay them back with interest. But what about scholarships and grants? That’s free money you receive for school — funds you don’t have repay.
According to Zimmelman, whether you claim scholarships and grants as income on your taxes depends on how you use the money.
“Financial aid and grants are generally not considered taxable income, provided the money is spent for tuition, fees, books, and other supplies for classes,” he said. “Grants and scholarship money used for other purposes like room and board must be reported as taxable income.”
Zimmelman also pointed out that you have to report income from work-study programs. Work-study is a type of financial aid, but it is still money earned. As such, it has to be reported to the IRS.
When student debt could be taxed as income
Even though student loans are not considered income when the money is disbursed to you, it doesn’t mean you’re totally in the clear.
“If your student loan debt is later forgiven instead of being paid back, it becomes taxable,” said Zimmelman. “The amount forgiven will be considered a cancellation of debt, which is taxable as income.”
When your loans are forgiven, you don’t have to pay the debt back. In most cases, it would then be considered money you received as a benefit, making it taxable income. This includes any forgiveness you may receive as the result of an income-driven repayment plan.
With these plans, your monthly loan payments are based on your income and you repay your debt for 20 or 25 years. Once that repayment period is complete, any remaining student loan balance is forgiven. At that point, the forgiven amount is considered income, meaning a higher tax bill for you.
The exceptions to this tax rule are Public Service Loan Forgiveness and Teacher Loan Forgiveness. If you qualify for these programs and your remaining loan balance is forgiven, you won’t have to pay taxes on the forgiven amount.
Before accepting a plan that involves student loan forgiveness, consider consulting with a tax professional to determine the impact.
Know your options ahead of time
In a perfect world, everyone would be able to afford college without having to worry about student loan debt. For most people, however, paying for college without help is practically impossible.
In most cases, your student loan debt won’t be taxed as income. But keep the situations when you could face a tax bill for student debt in mind. This way, you can complete your tax return accurately.
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