Did you know you could receive a tax break when you start paying off your student loans? There are also a few tax advantages if you are still in school. Depending on your income and tax-filing status, you may be able to deduct up to $2,500 in student loan interest from your taxable income each year.
Tip:The principal amount of your student loans is not tax deductible.
Student Loan Interest Deduction
Taxpayers who pay interest on federal or private student loans and qualify for the student loan interest deduction can reduce their taxable income by up to $2,500 per year:
The more income you earn, the less student loan interest you will be able to write off
American Opportunity Tax Credit
Students can claim up to $2,500 every year for up to four total tax years. This credit has strict qualifying requirements, including:
You must be attending school at least half time for at least one academic term
You are exempt if you have finished the first four years of a postsecondary program prior to the end of the tax year
You must be enrolled in a program that will result in receiving a degree or other recognized credential
Lifetime Learning Credit
Students can claim up to $2,000 in credit every year with less-stringent criteria than the American Opportunity Tax Credit:
There is no hourly minimum requirement to qualify
There is no limit to how many years you can claim this credit
You don’t need to be pursuing a degree to receive this credit
You can use the credit for courses that help you acquire job skills or for continuing education
How to Avoid a Student Loan Tax Bomb
Anything with “tax” and “bomb” in its name can’t be good and should be avoided at all costs. This happens when your loan balance is forgiven but you are still responsible for paying taxes on the amount, which primarily affects borrowers on income-driven repayment plans.
The Biden administration has mandated that any amount forgiven through income-driven repayment, or other means, is not considered taxable income through the end of 2025. After then, you could face a potentially large tax bill that will be due in full immediately.
To avoid that future bomb from going off, you should estimate your projected student loan forgiveness and set aside that amount.
Tip:If you have a forgiven student loan, you should receive a cancellation of debt form, known as Form 1099-C, for your taxes.
There Are Many Types of Student Loans
The two main types of student loans are federal and private. Within each type are subsets that might appeal to you based on your credit history, financial need, and other factors.
Federal loans were established to help students with limited funds, or a poor credit history, receive a good education. Private loans offer customized options to students with a strong credit history.