The deadline for millions of Americans to file their tax return is only days away. And for the country’s 40 million student loan borrowers, navigating repayment, student loan forgiveness, and taxes is more confusing than ever.
But for many people, there are strategies that can reduce your student loan repayment obligation, your tax burden, or both. Here’s an overview.
Reduce Adjusted Gross Income To Lower Student Loan Payments And Tax Bill
Millions of federal student loan borrowers rely on income-driven repayment (IDR) plans. IDR plans use a formula based on a borrower’s family size and income — typically, their Adjusted Gross Income (AGI) as reported on their federal tax return — to calculate their monthly payments. AGI is an individual’s gross (pre-tax) income, minus certain pre-tax deductions. IDR payments are typically recalculated annually through a process called income recertification.
IDR plans can result in eventual student loan forgiveness after 20 or 25 years (and even sooner for borrowers working in public service jobs). And with the rollout of the IDR Account Adjustment — a one-time initiative that may accelerate borrowers’ progress toward loan forgiveness (even for borrowers not currently in IDR) — these plans are an attractive option for many.
Reducing your AGI can reduce your taxable income, and thus result in a lower tax obligation. And for federal student loan borrowers in IDR plans, reducing your AGI can also lead to more affordable federal student loan payments.
There are multiple ways to reduce AGI. You can contribute to certain tax-deferred retirement accounts, such as a 401(k) or 403(b). Self-employed individuals can contribute to a solo 401(k) or a traditional tax-deferred IRA. You can also contribute to a Health Savings Account (HSA). Consult with your tax advisor for other AGI-reduction strategies.
Married Student Loan Borrowers Could Consider Filing Separately For Some IDR Plans
For married borrowers who file taxes jointly with their spouse, all four major IDR plans — Income Based Repayment (IBR), Income Contingent Repayment (ICR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE) — will factor in the combined income of the borrower and their spouse (although the plans will also consider the spouse’s federal student loan debt) when calculating an IDR payment. This means that a spouse’s added income could lead to higher monthly student loan payments under an IDR plan in certain cases.
Three IDR plans — IBR, ICR, and PAYE — will only consider a married borrower’s individual income if they file taxes as “married filing separately.” Filing separately often leads to higher tax liability for a household due to the loss of certain tax deductions; but if the annualized savings associated of a lower IDR payment is comparatively greater than the resulting additional tax burden, it could be worth it for some student loan borrowers to consider filing as married-filing-separately.
The REPAYE plan, unlike other IDR plans, currently factors in the combined income of married borrowers regardless of how they file their taxes. So even though REPAYE is a more affordable IDR plan than some other options, a spouse’s income could offset that relative affordability. The Biden administration recently proposed changes to REPAYE that would bring marital tax treatment in line with the other three IDR plans, although the Education Department has not finalized the overhaul or announced a timeline for implementation.
Ongoing Student Loan Pause May Impact Tax Filing Decisions
The Biden administration’s latest extension of the national student loan pause — which has suspended payments and frozen interest on most federal student loans — is set to end later this summer (although two new legal challenges are threatening to end the pause sooner).
Once the payment pause ends, borrowers who have been in an IDR plan should have their payments resume at the amount calculated based on their last income recertification — which for many borrowers, was in 2019 or 2020. And according to the Education Department, borrowers may not have to recertify their income again for months.
“On your account Aid Summary, you may still see a recertification date that is earlier than the end of the payment pause. We are working to get those updated, and we thank you for your patience,” according to updated Education Department guidance. “If your recertification date falls between now and six months after the pause ends, it will be pushed out by one year. For example, if your account says your recertification date is Dec. 1, 2022, that date will be pushed out to Dec. 1, 2023.”
The postponement of normal IDR income recertification deadlines could impact how some borrowers file their taxes this year, particularly with respect to married borrowers and whether they file taxes jointly or separately.
Get Student Loan Forgiveness Before 2026
Certain types of federal student loan forgiveness and discharge programs could be treated as taxable events for borrowers. Borrowers could receive a Form 1099-C, requiring them to report the amount of forgiven or cancelled student loan debt as “income” for tax purposes, potentially resulting in a hefty tax bill.
Some federal student loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness, have been tax-free under federal law for quite some time. But other programs have not.
Under the American Rescue Plan Act of 2021, federal student loan forgiveness, cancellation, and discharges are not subject to federal taxation through the end of 2025. A number of Biden administration initiatives, including the one-time cancellation program currently before the Supreme Court as well as the IDR Account Adjustment (which may result in widespread student loan forgiveness), could benefit from the temporary federal tax exemption. Borrowers may want to explore their eligibility for tax-free student loan forgiveness, although it is important to note that some student loan forgiveness events could still be taxable at the state level in some states, even if it is exempt from taxation federally.
Student Loan Interest Payments May Be Tax Deductible
Some borrowers may be entitled to a tax deduction for student loan interest paid during the year. Taking the tax deduction can reduce taxable income, resulting in a potentially lower tax burden.
“You can take a tax deduction for the interest paid on student loans that you took out for yourself, your spouse, or your dependent,” says the Education Department in published guidance. “The maximum deduction is $2,500 a year.” The tax deduction is phased out for higher income earners.
Most federal student loan borrowers did not have to make any payments on their loans in 2022 because of the ongoing student loan pause, and those who did may not have necessarily have paid any interest (payments on loan principal don’t qualify for the deduction).
But private student loan interest paid during the year can potentially qualify for the tax deduction. “This benefit applies to all loans (not just federal student loans) used to pay for higher education expenses,” says the Education Department.
Borrowers should receive a Form 1098-E statement from their student loan lender or servicer notifying them of student loan interest paid during the year.
New Employer-Based Student Loan And Retirement Match Benefit
Legislation passed last year will provide some student loan borrowers with a new employer-based retirement benefit. The benefit allows payments a borrower makes on their student loans to be treated as retirement plan contributions for the purpose of company retirement matches associated with employer-sponsored retirement plans, like a 401(k). In other words, if you pay $100 towards your student loans, your employer could provide a matching contribution of $100 towards your 401(k) plan.
This benefit may allow student loan borrowers to save for retirement while also paying down their student loan debt. And for borrowers in an IDR plan, contributing to a tax-deferred retirement account can also lower their AGI, potentially reducing their IDR payments in subsequent years, as well.
Employers are not required to offer this benefit, but they can opt in. The benefits are still limited by normal plan-based contribution limits, and employees must certify their student loan payments to their employer to receive the match.
Talk To A Professional
Student loan borrowers interested in exploring tax strategies or options for reducing their student loan payments should consult with a qualified professional such as a Certified Public Accountant (CPA), a Certified Financial Planner (CFP), or a licensed attorney in good standing in their jurisdiction.
The Education Department cautions borrowers about rampant student loan assistance scams. “If you’re unsure whether to pay a company for help finding financial aid, stop and think for a minute: What’s being offered? Is the service going to be worth your money? Do the claims seem too good to be true?”