If you are paying off students loans, then there is a special tax consequence and benefits that apply to you. A student loan interest deduction, taxes on student loan debt that a lender forgives, and your filing status, if you are married, will all have a significant effect on the tax bill of student loan borrowers.
The Student Loan Interest Tax Deduction
The student loan interest deduction is a tax deduction you can claim every year when you file your taxes. It is usually the deduction option that is more valuable. You should receive a formed called the 1098-E Student Loan Interest Statement from your loan servicer every January or February. You will only receive this form if you paid more than $600 in student loan interest that tax year. If you paid less than this amount, then you can still claim the deduction. All you will need to do is just add up the interest amounts from your payment statements. You will want to consult your tax preparer or IRS Publication 970 for instructions on how to calculate the deduction.
When a creditor forgives your debt, the IRS considers the forgiven amount to be income to you. There are exceptions to this. If you are repaying your student loans under an income-driven repayment plan, then the government will forgive any unpaid balance that remains when you are done with your repayment term. You will want to be prepared for a significant increase in your tax bill for the year that the balance of your student loan is forgiven. If the IRS believes you owe taxes on forgiven debt, you will be sent a form called a 1099-C.
There are many exceptions to this tax effect. Forgiven debt does not count as taxable income when your debt is forgiven as part of a job-specific student loan forgiveness program, school-related loan discharges, if your student debt was discharged in bankruptcy because you proved, “undue hardship”, and insolvency.
Filing Status for Married Couples With Student Loans
Married people can file their taxes as married filing jointly or married filing separately.
There can be some negative tax consequences unrelated to student loans if you file as married filing separately. On the other hand, if you are repaying your loans as part of the Income Based Repayment, Income Contingent Repayment, or Pay as You Earn programs, there are good reasons to consider filing as married filing separately. Your monthly payment under the income-driven repayment plans is set each year, and the amount is based on your income. If you file as married filing separately, then the government will only consider your income when setting the amount of your payment.