Most of us know we need to pay attention to things like our mortgages when doing our taxes. But who would imagine that student loan debt could possibly help you get a bigger tax refund?
Here’s a look at how you might be able to write off some interest paid on student loans, as well as other tax tips relating to college debt. Big clue: Don’t default if you want a fat tax refund.
Despite some rumors to the contrary, many people can lower their tax bill by tapping into a deduction on federal income tax returns for interest paid in 2018 on federal and private student loans.
“It’s a nice benefit to have,” said Cari Weston, director of tax practice and ethics for the American Institute of CPAs.
But she warns that it’s a tax break that only applies to a limited group of people, often younger consumers who aren’t making much money. Married couples — who both are paying off student loans — face some unexpected limits, too.
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The good news is that it’s possible to claim this deduction even if you take the standard deduction.
“It’s not an itemized deduction,” said Jackie Perlman, principal tax research analyst at H&R Block’s Tax Institute.
Under the Tax Cuts and Jobs Act of 2017, more people will take the standard deduction instead of itemizing. Even if that’s the case, you could still be able to use the deduction for student loan interest if you qualify, Perlman said.
It’s an above-the-line tax break so it would reduce your taxable income by up to $2,500.
But again, it’s one tax break that you cannot always bank on.
Weston said clients may hear about the deduction but not realize all the hurdles.
“People get very confused,” Weston said.
As a CPA, she’s had to break the bad news and tell clients things such as: “But in your case, you make too much money, and you’re not going to get it.”
If you’re single, for example, the dollar amount of the student loan deduction starts being reduced significantly once your modified adjust gross income goes above $65,000. If single, you can’t claim it at all if your modified adjusted gross income is $80,000 or more.
For 2018, the phase out limit for married couples is between $135,000 and $165,000 if you file a joint return. You can’t claim the deduction once you hit $165,000 or more if you file a joint return.
You’re not eligible for this deduction if married filing separately. Some married student loan borrowers do file separately to be able to have lower monthly payments under income-driven repayment plans. As a result, though, they could lose out on the deduction for interest payments on student loans.
You cannot claim this deduction if you or your spouse, if filing jointly, can be claimed as dependents on someone else’s return.
In the case of married couples, the deduction is per return, not per person.
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If two borrowers get married, their deduction will drop from up to $2,500 each on single returns to one combined $2,500 deduction on the joint return, warned Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com.
So if you’re newly married, don’t expect that you both can take this tax break.
“I call this the classic marriage penalty,” Weston said.
Read the rules carefully. See Chapter 4 of Publication 970: Tax Benefits for Higher Education for information on the student loan deduction. Go to www.irs.gov.
There is a worksheet for filling out the student loan interest deduction, which you’d claim on Schedule 1 for the 1040, Line 33.
Make sure to see Line 7 Adjusted Gross Income to claim the deduction on page 2 of the new shorter 1040 form.
It could be confusing to some. You don’t see the student loan deduction spelled out on the 1040 form even though you’d include it on Line 7 under adjusted gross income.
Student loan help from employers is taxable
Some employers, such as Dearborn, Michigan-based Carhartt, now are offering job perks that include paying some money toward student loan debt. Currently, though, payments under employer loan repayment assistance plans are taxable to the employee.
“It’s not a tax-free perk from your employer,” Perlman said.
Scott Thompson, CEO of Tuition.io, a California-based platform for employee student loan contributions, said some employers will “gross up” and offer more money to cover the extra taxes. But not all employers do that, so employees need to take time to understand the benefits that are spelled out.
In the future, you might get a better break.
Kantrowitz noted that there is bipartisan legislation in Congress — dubbed the Employer Participation in Repayment Act — that would exclude up to $5,250 in such benefits from taxes a year.
Student loan forgiveness is mixed bag
The good news is that student loan debt that is discharged after Dec. 31, 2017, because of the student’s death or disability is no longer taxable. This tax break expires after 2025, and the disability must be a total and permanent disability, according to Mark Luscombe, principal analyst for Tax & Accounting at Wolters Kluwer in Riverwoods, Illinois.
The change was part of the Tax Cuts and Jobs Act of 2017, which took effect in 2018. The new rule isn’t retroactive. It applies to federal or private education loans.
Kantrowitz said his research and reading of the statute is that this new change applies to the discharging of debt on a Parent PLUS loan when the student dies. Some tax experts, though, say more guidance may be needed from the IRS on some specific issues.
But other types of student loan forgiveness may be taxable currently. You’d receive a 1099-C if the cancelled debt is $600 or more.
But it’s important to research the exceptions to what’s taxable and what isn’t, Kantrowitz said.
Student loan forgiveness, for example, that’s associated with working in certain occupations for a set period of time is tax free. That includes Teacher Loan Forgiveness and Public Service Loan Forgiveness.
Many times, borrowers need to work in certain under-served areas to qualify for such forgiveness, Weston noted.
It’s important to understand all the specific rules so you’d qualify for loan forgiveness and be able to avoid being taxed on any benefits.
“Sometimes, people are blindsided by that,” Perlman said.
To exclude canceled student loan debt from your income, your loan must have been made by a qualifying lender to attend an eligible financial institution.
So, for example, such exclusions relating to this tax break wouldn’t apply to any cancelled credit card debt, Perlman said.
Sometimes, students can become overwhelmed with credit card debt too, especially if they pay for tuition with a credit card and then let that interest build and build.
Defaulting on student loans reduces refunds
Tax filers are often shocked when they expect a tax refund of $5,000 or more and then discover they’re not getting all that money. Some or all may be used to pay back a federal student loan that was in default.
If you’re missing money out of your tax refund, it’s possible it was collected through the Treasury Offset Program to collect delinquent debts owed to federal agencies and state governments.
“Most people are going to have ample notice before a refund is garnished,” said Weston, at the American Institute of CPAs.
“Just simply not paying your loan for a month or two is not going to send them into that kind of aggressive action,” she said.
Student loan default takes place when you don’t make the required payment on your student loan for 270 days — or nine months — or more. Default is more serious than delinquency .
Some students, though, do lose track of loans when the debt is sold to another lender and unknowingly they don’t make payments. After not making those payments, some report being shocked to have their tax refund garnished.
Defaulting, of course, also can hurt your credit score and drive up the cost of taking out a mortgage or a car loan.
Contact Susan Tompor at 313-222-8876 or firstname.lastname@example.org. Follow her on Twitter @tompor. Read more on business and sign up for our business newsletter.