Student loans and taxes — that sounds like a list of your most hated things, right? Both can eat up a large portion of your paycheck. Even worse, they can be confusing and stressful.
But your student loans can actually save you money when tax season begins. Your loans and education expenses can lower your tax liability when you file your return thanks to the student loan tax deduction and other tax benefits.
A tax deduction lowers your taxable income, which means you owe less money to the IRS. For example, if you earned $50,000 through your job and qualified for a $5,000 deduction, the IRS will consider your taxable income to be just $45,000.
If you have student loans or education-related expenses, you could qualify for one of these valuable deductions that lower your taxable income and reduce your tax bill:
1. Student loan interest tax deduction
If you’re making payments on your student loans, a portion of your monthly payment goes toward accrued interest, rather than the principal. You can deduct up to $2,500 in interest payments from your taxable income. Best of all, you don’t need to itemize your deductions to qualify.
You can claim this student loan tax deduction if you meet the following criteria:
- You paid interest on a qualified student loan during the tax year
- You’re legally obligated to make payments on the loan
- Your filing status is not married filing separately
- Your modified adjusted gross income (MAGI) is under $80,000 (or $160,000 if you file a joint return)
- No one claims you as a dependent
You can claim the full deduction if your income is under $65,000. If your income is between $65,000 and $80,000, you will receive a smaller deduction. Those who make more than $80,000 are not eligible for the student loan tax deduction.
Qualified student loans include both federal and private loans. The loan must have been for you, your spouse, or your dependent to be eligible.
If you paid $600 or more in interest payments on your student loan, your loan servicer will send you Form 1098-E, the Student Loan Interest Statement. If you paid less than $600, you won’t receive a form from your servicer, but you can still claim a deduction by totaling the interest payments on your statements yourself.
2. Tuition and fees deduction
If you’re still in school or were enrolled at a university during the tax year, you could deduct up to $4,000 in qualified education expenses. You’re eligible for the tuition and fees deduction if you, your spouse, or a dependent was enrolled in school.
You can deduct what you spent on college tuition, fees, books, supplies, and equipment required by the school for courses. However, expenses like room and board, transportation, and health care are not eligible.
To claim the deduction, you must complete Form 8917, the Tuition and Fees Deduction.
While a student loan tax deduction lowers your taxable income, a tax credit reduces how much in taxes you have to pay. It’s applied after you figure out what you owe, sort of like a coupon code you use when shopping online.
Depending on the credit, you could even see your tax refund increase, putting more money back in your pocket. There are two education-related tax credits you might be able to claim on your return:
1. Lifetime Learning Credit
The Lifetime Learning Credit (LLC), worth up to $2,000, is for tuition and other educational expenses. Qualifying expenses are those you paid directly to the school for undergraduate, graduate, and professional degree courses, including development classes you take during your career to learn new skills.
To be eligible for the LLC, you must:
- Be enrolled or taking courses at an eligible school
- Pursue a degree or professional credential
- Attend school for at least one academic period during the tax year
To claim the full value of the credit, you must make $65,000 or less, or $130,000 or less if you file a joint return. If your income is between $55,000 and $65,000, you will receive a reduced credit. Those with incomes over $65,000 (or $130,000) are ineligible for the credit.
If you paid tuition or other qualifying expenses during the tax year, the school will send you Form 1098-T, the Tuition Statement. This form details how much you paid to the school. You will use that information to fill out and submit Form 8863 to claim the credit.
The LLC is not refundable, meaning you won’t receive the remaining amount if the credit reduces your tax bill to $0. And if you’re receiving a tax refund, you can’t claim the credit; you can only use it if you owe money to the IRS.
2. American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) is worth up to $2,500 if you paid for enrollment fees and course materials during your first four years of school.
The AOTC is one of the most valuable credits because it’s refundable; if the credit brings your tax bill to $0, you can receive some money back in the form of a tax refund. With the AOTC, you can receive 40 percent of the remaining amount — up to $1,000 — in cash.
To qualify, students must:
- Be pursuing a degree or other credential
- Enroll at least half time
- Not have claimed the credit for more than four years
- Not have a felony drug conviction
Like other deductions and credits, the AOTC has some income restrictions, too.
You earn the full tax credit if your income is $80,000 or less, or $160,000 or less if married filing jointly. If your income is higher than that benchmark, you can claim a reduced amount of the credit. But if you make more than $90,000, or $180,000 for married filing jointly, you can’t claim the AOTC at all.
You can only claim expenses directly paid to your school for tuition or other costs. Groceries, utilities, and other bills are not eligible.
To claim the credit, you will need to complete Form 8863. However, before submitting your form, review the qualifications carefully and ensure you meet the requirements. If you file for the credit and the IRS finds that your claim is incorrect, you could pay a penalty. If that happens, you could be ineligible for the AOTC for up to 10 years afterward.
It’s important to know that you can’t claim both the LLC and AOTC. Even if you’re eligible for both credits, you must select one when you file your taxes. If you do qualify for both, the AOTC is often a smart choice because you might receive extra money back.
Filing your return
When it comes to student loans and taxes, there are a lot of credits and deductions to keep track of and claim. Although it can be overwhelming, it’s important to remember them and submit the necessary forms to save money and ensure you get the maximum refund you deserve.
Even better, you can use that larger refund to make an extra payment on your loans.
If the thought of the upcoming tax season fills you with dread, don’t panic. Our guide for completing your taxes for the first time can help you navigate through the process painlessly.
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