Your student loans have been canceled – Will you have to pay taxes on the canceled debt?


On Wednesday, President Biden announced plans for several student loan relief efforts, including federal student loan forgiveness from $10,000 to $20,000 per borrower. With more than 43 million Americans holding federal student loan debt of approximately $37,667 per borrower (not including private loans), many will see their debt balances shrink dramatically, if not disappear altogether.

If your student loans are cancelled, either by the recent announcement, the Civil Service Loan Cancellation Program or an income-based reimbursement (IDR) plan, will you owe taxes on the amount remitted? Here’s everything you need to know about student loans and taxes, plus some additional tax relief you may be eligible for next year.

Will you owe additional taxes if your student loans are forgiven?

Typically, when you receive student loan forgiveness, your forgiven debt is added to your taxable income come tax season. This increases the amount of tax you owe for a given year, either by reducing your refund or by increasing your tax bill.

For example, if you earn $50,000 and have $20,000 in canceled student loans, your taxable income would jump to $70,000, pushing you into a higher tax bracket.

However, a provision inserted in the $1.9 trillion in COVID relief passed in March 2021 eliminates taxation on canceled student loan debt until 2025. This means you will not owe any additional tax on your canceled student loans.

Other tax considerations for those with student loans

In addition to student loan forgiveness optionsyou may be eligible for tax credits and deductions. Although the 2023 tax thresholds have yet to be released, here are some student loan tax breaks that could increase reimbursement next year or reduce your tax bill.

Student loan interest deduction

When you make monthly payments on your student loans, this includes your principal payment plus any accrued interest payments. Whether you have private or federal student loans, the student loan interest deduction allows you to reduce your taxable income, depending on the amount of interest you paid. For 2021, this reduction has increased to $2,500 per year.

You are eligible for the deduction if you paid interest on a student loan in the particular tax year and you meet the modified adjusted gross income requirements (your income after taxes and allowable deductions). For 2021, you qualify if your MAGI was less than $70,000 (or $100,000 if married, filing jointly). Partial deductions were offered for those with MAGI between $70,000 and $85,000 ($100,000 – $170,000 for those who filed jointly).

With federal student loan payments on pause and interest at 0%, you may not have paid any interest in the past year. That said, you must log into your student loan portal and verify Form 1098-E for any qualifying interest payments.

If eligible, this deduction will reduce your taxable income, which could reduce the amount you owe the IRS or increase your tax refund. You could even be placed in a lower tax bracket, which could entitle you to other deductions and credits
.

US Opportunity Tax Credit

The American Opportunity Tax Credit is available to new students during their first four years of graduate school. It allows you to claim 100% of the first $2,000 of eligible educational expenses, then 25% on the next $2,000 spent, for a total of up to $2,500. If you are a parent, you can claim the AOTC per eligible student in your household, provided they are listed as a dependent.

To claim the full credit in 2021, your MAGI must have been $80,000 or less ($160,000 or less for married people, filing jointly). If your MAGI was between $80,000 and $90,000 ($160,000 to $180,000 for those filing jointly), you may be eligible for a partial credit.

The AOTC is a refundable credit, which means that if it reduces your income tax to less than zero, you may be able to get a refund of your taxes or increase your existing tax refund.

Lifetime learning credit

You can recover money for eligible education expenses through the Lifetime Learning Credit. The LLC can help pay for any level of continuing education courses (undergraduate, graduate, and professional degrees). Transportation to college and living expenses are not considered eligible expenses for the LLC.

Unlike the AOTC, there is no limit to the number of years you can claim the credit. You could get up to $2,000 each year or 20% on the first $10,000 of eligible education expenses. However, the LLC is non-refundable, meaning you can use the credit to reduce your tax bill if you have one, but you won’t get any credit back as a refund.

For 2021, you were eligible for this credit if you had qualifying expenses and your MAGI was less than $59,000 ($118,000 for married people, filing jointly). You could also claim a reduced credit if your MAGI was between $59,000 and $69,000 ($118,000 and $138,000 for married people, filing jointly).

To note: You cannot apply for both AOTC and LLC for the same student in the same tax year. If you qualify for both, the AOTC generally provides greater tax relief (and may increase your refund).

If your loans are in default, will next year’s tax return be seized?

Normally, if you have federal student loans in default (meaning you are unable to pay what you owe for 270 days), your tax refunds can be used to cover the balance owing. Since federal student loans were on pause during the 2022 tax season, your federal tax refund was not eligible for government garnishment.

It’s unclear if this will remain in place for 2023, but with the new payment break set to expire at the end of 2022, this benefit may expire.

Your tax filing status may affect your student loan payments

If you repay federal student loans and follow an income-based repayment plan, your marital status may affect your payment amount. For example, if you are married and filing jointly, your payments are based on the joint income between you and your spouse. If you are married and file separately, your payments are based on your income only.

However, if you decide to file separately to lower your monthly IDR plan payment, you may miss out on other key tax benefits. For example, you may not be able to take advantage of a lower tax rate given to married couples who file jointly, nor will you be able to claim increased credit and deduction amounts available if you file jointly.

The revised Pay As You Earn, or REPAYE, plan does not distinguish between whether you are listed as married filing separately or married filing jointly. Your payments are based on your income and that of your spouse.

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