How to make your student loans work for you at tax time
Nobody likes tax season. There’s paperwork to get in order, and seeing a chunk of your salary disappear is never enjoyable.
But if you’re paying off student loan debt, you may be able to save some money on your taxes — the interest portion of your payments is deductible.
The student loan interest deduction allows you to reduce the amount of your income that’s subject to tax by up to $2,500, which means you could save as much as $625 on your taxes.
But how do you go about claiming the student loan interest deduction, and what else do you need to know about saving money?
The student loan interest deduction
A $2,500 tax deduction does not mean that you will get $2,500 back from the government. A deduction simply means that you could lower your taxable income by up to $2,500.
So if you qualify to deduct $2,500 and you have a marginal tax rate of 25 percent, you would pay $625 less in taxes. But keep in mind that this is the best case scenario — if your tax rate is 15 percent, for example, you would only save $375.
You can claim this deduction if you’ve refinanced your loans, and if you’re the parent of a dependent child who took out the loan.
You’re eligible to claim the deduction if:
- You paid interest on a student loan during the 2015 tax year
- The student loan is in your name
- You were enrolled at least half-time in a degree program when you took out the loan
- You’re filing as a single taxpayer or as “married filing jointly”
- You have a modified adjusted gross income (MAGI) of less than $80,000 as a single taxpayer or $160,000 if you are filing jointly
- Nobody else is claiming you as a dependent on their tax return
If you’re married, there’s a caveat — there’ s no double dipping allowed. If both you and your spouse are eligible to claim a $2,500 deduction, you can’t both claim a deduction totalling $5,000. Whether you’re married or not, you can only claim a single deduction, totalling a maximum of $2,500.
The amount of money you get back through the deduction will depend on how much you earn as income, and how much you deduct. You can use calculators, like this one from TurboTax, to estimate how much money will be refunded to you if you claim your deduction. The IRS also provides this worksheet to help you calculate how much your deduction will be.
The student loan interest deduction is a nice perk. But if you’re paying a lot of interest on your student loans, you may be able to save a lot more than $625 a year by refinancing your loans at a lower interest rate with a private lender. Borrowers refinancing their loans with vetted lenders through the Credible.com platform save $11,668 on average. It takes just two minutes to find out how much you might save.
Long-term tax issues
Here are a couple more student loan tax issues to keep in mind for the long run. If you’re enrolled in an income-driven repayment plan, you could be eligible for loan forgiveness after 20 or 25 years.
But under the current tax code, forgiven student loan debt (principal and interest) is taxable as income. A borrower making $50,000 a year in adjusted gross income when they begin paying back $100,000 in graduate student loan debt could end up facing a $26,700 tax bill under one popular plan, PAYE. The newest income-driven repayment plan, REPAYE, includes a subsidy that counts only half of the unpaid interest as forgiven debt, so the tax bill would be smaller — about $16,000 (for more details on this and other borrower scenarios, see Credible’s REPAYE guide).
The Obama administration wants to defuse this “student loan tax time bomb,” but there’s no guarantee Congress will repeal the tax on forgiven student loan debt.
In the meantime, wouldn’t it be nice if you could pay down your student loans with pre-tax earnings? Currently, employers can contribute pre-tax earnings to help employees pay for continuing education. But when you pay down student loan debt, you’re using income you’ve already been taxed on.
Some lawmakers want to change that. The Employer Participation in Student Loan Assistance Act would allow up to $5,250 in payments a year to be made from pre-tax earnings. The House version of the bill now has 14 cosponsors, and a companion bill has been introduced in the Senate.
Ariha Setalvad is a member of the DailyWorth Connect program. Read more about the program here.