Tax Tips: Student Loans and Your 2013 Tax Return

Tax Return 1040As you get ready to file your 2013 tax return, review these tax tips if you have student loan debt. Understanding how taxes and student loan payments intersect could help you save money. And if you will soon pay off a student loan with forgiven principal, you might need to prepare yourself for a tax hit.

Tax Tip 1: You Might Be Able to Deduct Interest on Student Loan Payments

If you paid interest on student loans during 2013 and your modified adjusted gross income (AGI) is less than $75,000 if you are single, and less than $155,000 if you are married filing jointly, you can deduct up to $2,500 on your 2013 federal taxes. (There is no deduction if you are married filing separately.)

The amount you can deduct depends on:

  • How much student loan interest you paid.  If you paid less than $2,500, then your deduction is limited to the amount you actually paid.
  • How much income you earned. If your AGI is between $60,000 and $75,000 for singles, or between $125,000 and $155,000 for married couples filing jointly, the IRS prorates your deduction.  This means your deduction will be lower than if your income was less than $60,000 (single filing) or $125,000 (married filing jointly).

For details on the formula for determining your tax deduction, what counts as a student loan interest, and examples of how this works, see Nolo’s article Tax Deductions for Student Loans.

Tax Tip 2: Filing Status Can Reduce Your Future Student Loan Payments

If you are married and are paying student loans under one of the federal income-driven student loan repayment programs, your filing status can affect your student loan payment amount for the next year.

Under the federal Income Contingent Plan (ICR), the Income Based Plan (IBR), and the Pay as You Earn Plan (PAYE), the amount of your student loan payment is based on your income, family size, and basic living expenses. Each year, the loan servicer uses the information in your tax return to reset the amount of your student loan payment. (Learn more about how these repayment plans work in Nolo’s article What’s the Difference Between Income Contingent Repayment Plans and Income Based Repayment Plans?)

If you are married and file a joint tax return, your loan servicer will consider the income of both you and your spouse in setting your student loan payment  amount. But, if you are married and file a separate tax return, your loan servicer will consider only your income when setting your student loan payment amount. If your spouse’s income is significant, filing separately could reduce your student loan payment for the next year.  (For more information and examples of how this works, see Nolo’s article Tax Filing Status and Student Loan Payments.)

Tax Tip 3: If You Have Forgiven Student Loan Debt, You Could Face a Tax Hit

If you enter into one of the federal flexible student loan repayment plans, such as ICR, IBR, or PAYE, your student loan payment is determined by your income. After you have made payments for the full loan term (which can be up to 30 years), if any debt remains, the federal government will forgive it.

The problem, come tax time, is that the IRS treats forgiven debt as income. If the forgiven student loan amount is more than $600, your loan servicer will send you a 1099-C and you’ll have to report the forgiven debt on your tax return as income. This can result in a hefty tax increase.

Fortunately, there are some exceptions to this tax rule. For starters, forgiven loan debt for some types of student loan forgiveness programs doesn’t count as income for IRS purposes.  If the government discharged (wiped out your loan) for certain reasons, that also does not count as income. And you might be able to avoid a tax bill if you were “insolvent” at the time of forgiveness. (Learn more about the exceptions to paying income tax on forgiven student loan debt.)

If the federal government has forgiven, or will soon be forgiving, some of your student loan debt, talk with a tax expert to determine your tax liability, any exceptions you may qualify for, and how to prepare for the tax hit, if it comes to that.