How Student Loans Can Affect Your Taxes

Family in Litchfield, NH Has New College Student and Questions

The interest paid on student loans can be taken as a tax reduction, reducing the taxable income. Using Form 1098-E, which is sent by the lending institution at the end of the year, you can deduct up to $2,500 in annual interest on these loans. This tax deduction applies to all loans used to pay for higher education, not just federal loans. This tax break is an above the line deduction that can wind up saving you a few hundred dollars. However, to qualify for this deduction you must have paid the interest. Those who have their payment paused on an interest waiver are not eligible.

If you qualify for assistance or complete forgiveness for your student loans, depending on the type of loan that you have, you may be taxed as income on this payoff.

A family in Litchfield was trying to get a better understanding of how their college student’s taxes would be affected by loans used for his higher education. They contacted Merrimack Tax Associates with their questions.

Student Loan Forgiveness and Its Effect on Your Taxes

If you are eligible and receive student loan forgiveness, you may have to pay taxes on this payoff money which will be taxed as income. This depends on the type of loan and the forgiveness that you receive. Loan forgiveness on an income-driven repayment plan is not taxable through 2025 as covered under the American Rescue Plan Act. Loan forgiveness extended through the Teacher Loan Forgiveness and Public Service Loan Forgiveness are both tax-free. Federal student loans forgiven after 20 years in an income-driven repayment plan are taxable.

For those loans that are forgiven, you should take the time to learn how this will affect your taxes based on the loan type and forgiveness. This way there will not be any surprises when it comes time to file your taxes. If you are required to pay taxes on this payoff, as it is considered income, you can plan and budget accordingly for this.

The Litchfield family was pleased to know that their college student would be able to deduct up to $2,500 of student loan interest on his taxes and can enjoy this deduction for the duration of the loan.