Student Loans and Taxes

Choosing to attend a university can mean a lot of changes in your life. Some are for the better – you’ll have new career prospects and, hopefully, a higher salary than if you were to head directly into a career after high school. But some changes are a bit daunting, and maybe a little confusing. For instance, student loans and taxes.

When you graduate college (or even while you’re still attending) you’ve got more important things to think about than student loans and taxes. But knowing a bit about how these tax deductions and credits work can save you a lot of money – and headache – in the long term.

Student Loans and Taxes

According to the College Board, the average cost of tuition for college for one year is just about $35,000 if you attend a private university. It’s just shy of $10,000 for state school students. And if you’re attending a public university from out of state, you’ll pay an average of $25,620.

Think about that. Even if you decide to attend a community college, with an average cost of around $4,000 per year, that’s a lot of money! You could buy a car with that, or save toward a down payment on a home. For the cost of one year’s private tuition, you could put a down payment on a home.

Obviously, you want to see if you can get any of that money back. Thankfully, there are a few deductions and credits you can claim when you file your taxes that will help you do just that.

The American Opportunity Tax Credit

Student Loans Taxes

The first credit you’ll want to look into is the American Opportunity Credit. This credit pays 100% of the first $2,000 of qualified education expenses you pay each year. Then, it will pay 25% of the next $2,000. In other words, you can get up to $2,500 back in your tax refund.

This isn’t just a reimbursement, either. If the tax credit brings your total annual tax due down to zero, you can still get 40% of the remaining amount of the credit paid to you, up to $1,000.

Confusing? Let’s say you’re not working while you’re in school. You don’t have any income, so you don’t owe taxes. However, you used your savings to pay for community college, totaling $4,000. Claiming the American Opportunity Tax Credit will mean you get a tax refund check of $2,5000 assuming no other factors.

This credit applies to the first four years of school.

The Lifetime Learning Credit

The second credit you’ll want to check out is the Lifetime Learning Credit. The Lifetime Learning Credit applies toward any courses you take that will help you gain job skills. This may include degree programs or even something like a cosmetology license.

There’s no limit to the number of years you can claim the Lifetime Learning Credit, as you may have gathered by its name. The credit is worth up to $2,000 per tax return.

Scholarships and Grants

Scholarships and grants may not help you too much on your tax return, but they’ll certainly help your wallet. Scholarships are, in some cases, not taxable income. While the law may vary based on the scholarship, a good rule of thumb to follow is this:

  • If your scholarship is used only toward the cost of tuition, books and qualified expenses, it’s probably tax-free.
  • If your scholarship is used for cost of living or is part of a fellowship program, it’s probably taxable income.
  • If the scholarship is part of a non-degree program, it’s probably taxable.
  • If you have any doubt, check with a tax advisor.

Grants are considered gifts. In most cases, gifts are taxable. However, if your grant goes toward the cost of tuition or books, it’s extremely likely that it’s not considered taxable income by the government.

Are Student Loans Tax Deductible?

Taxes and Student Loans

So what about student loans? Let’s say you can’t afford your college tuition outright, and you don’t qualify for grants or scholarships. You’ll need to take out a student loan; are student loans tax deductible?

Well, no. But the interest might be.

Usually, college students will defer their student loan repayments until after graduation. Otherwise, they’ll make payment only on the interest, choosing to repay the principal at the start of their career. Whichever you choose to do, here’s what you need to know.

  • Only your student loan interest is tax deductible. You can’t claim a deduction on payments you’ve made toward the principal of your loan.
  • There are income requirements for this deduction. You can only deduct your interest if your income is below the national limit, based on how you file.
  • There are annual limitations. The max in 2017 was $2,500.
    Claiming the maximum does not mean you’ll receive a refund of that amount. It simply means your tax owed may be reduced.
  • Your loan must be from a qualified lender; it can’t be from friends, family or an employer.

Claiming student loan interest on your tax return assumes that you’ve actually spent the principal on school. In other words, you could get into some trouble if you took out a student loan and used the money, instead, to buy new carpeting.

Filing Your Taxes with Student Loans

Filing your taxes with student loans may sound confusing. Fortunately, the IRS has begun to require that lenders and other organizations send documentation to your address. For instance, your deductible student loan interest will be reported to you on Form 1098-E, which will be mailed to your home.

There are also tons of software programs which make the process of filing your taxes with student loans a snap. It’s basically plug and play for tax filers. You’ll enter your income into the software, then add any interest, scholarships or other specifics. The software will do the work for you, scanning for any credits you may be eligible for. In most cases, the software will even allow you to file your taxes online.

Learn More

We have many more articles on the subject of taxes and student loans, so if the above information left a few questions unanswered then take a look at the guides below: