If you have student loans, you may be eligible for a tax credit. The American Opportunity Credit is available to taxpayers who are paying off student loans. If you’re an employee and your employer has provided you with tuition assistance, you can also claim this credit. In this post, we convey the details of tax credit for paying off student loans, do you get money back for paying student loans, parents paying student loans tax deduction, tax implications paying off someone elses student loans and student loan interest deduction phase out 2020.
If you qualify for the student loan interest deduction, you can get up to $2,500 back each year on your federal tax return. This deduction is available to anyone who has paid at least $600 in interest on their student loans during the year. Read on to know more about tax credit for paying off student loans, do you get money back for paying student loans, parents paying student loans tax deduction, tax implications paying off someone elses student loans and student loan interest deduction phase out 2020.
student loan tax deduction
In this guide, we consider the details of tax credit for paying off student loans, do you get money back for paying student loans, parents paying student loans tax deduction, tax implications paying off someone elses student loans and student loan interest deduction phase out 2020.
Paying off your student loans can be a long and arduous process, but it’s worth it! 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. If you’re still attending school, you may also qualify for one of two different education tax credits: the American opportunity tax credit and the lifetime learning credit.
If you’re struggling to make payments on your student loans, consider making an extra payment or consolidating them into one loan with a lower interest rate.
Don’t forget about other options for paying off debt like refinancing or switching to a credit card with a better interest rate.
do you get money back for paying student loans
Next, do you get money back for paying student loans, parents paying student loans tax deduction, tax implications paying off someone elses student loans and student loan interest deduction phase out 2020.
You might not know it, but the federal government has a program that refunds your student loans if you can prove that you have financial hardship. The program allows borrowers to get money back for paying student loans.
However, borrowers who now need money can request a refund of any federal student loan payments made on or after March 13, 2020. If you made any extra payments before that day, you will not be able to get a refund.
In order to qualify for this program, borrowers must submit an income-driven repayment plan application and meet certain criteria. For example, the borrower must show their adjusted gross income is less than 150 percent of the poverty line for their state and family size.
parents paying student loans tax deduction
More details coming up on parents paying student loans tax deduction, tax implications paying off someone elses student loans and student loan interest deduction phase out 2020.
As a college student, you’re probably used to hearing about the financial burden of student loans. But did you know there’s a tax break for parents who took on debt to pay for their kids’ education?
It’s called the student loan interest deduction and it allows you to deduct up to $2,500 in interest paid from your taxable income. This means that every dollar you don’t have to pay in taxes can go toward paying off your student loans faster!
So how do you take advantage of this deduction? First, make sure that you’re claiming it on your taxes. If you don’t already file taxes as an individual or jointly with your spouse and were not required to file last year, then you might need to file an amended return (Form 1040X) or Form 4868) with the IRS.
Next, gather all of your information together: You’ll need copies of any promissory notes or contracts related to your student loans as well as any other documents that help show how much interest was paid during the year.
If you’re married filing jointly with your spouse, make sure that both of your Social Security numbers are included on any forms submitted—this will help ensure that each spouse gets credit for their own portion of the deduction.
tax implications of paying off student loans
The student loan interest tax deduction is designed to reduce your taxable income, based on how much student loan interest you’ve paid during the year. It’s important to note that you don’t receive a deduction based on how much you’ve made in payments. Instead, you can only deduct your interest payments, up to $2,500.1
The student loan interest tax deduction is an above-the-line deduction, meaning you don’t have to itemize in order to claim it.
How to Qualify for the Student Loan Interest Tax Deduction
In order to qualify for the student loan interest deduction, you must meet the following criteria:
- Have paid interest on a qualified student loan, which is one used for education purposes for yourself, a dependent, or a spouse
- Be legally obligated to pay interest on the student loan
- Married filing separately is not your filing status
- Your modified adjusted gross income (MAGI) is below the threshold set by the Internal Revenue Service (IRS) each year1
If you paid interest on your student loans, your loan servicer will send you a 1098-E if the interest you paid amounted to at least $600 during the year; however, even if you paid less than that amount, you can request a 1098-E from your lender or servicer. This document will tell exactly how much student loan interest you paid and how much you can deduct.2
Deductions can reduce the amount of your income before you calculate the amount of tax you owe. Credits can reduce the amount of tax you owe dollar for dollar. A deduction reduces your taxable income, unlike a credit, which reduces the amount of tax you pay. The student loan interest deduction is not a dollar-for-dollar reduction of your tax bill.3
Student Loan Forgiveness and Taxes
If you’re eligible for student loan forgiveness, you might also be on the hook for taxes, depending on the situation. This can be an unpleasant surprise if your student debt is forgiven or is partially forgiven, and then you still need to pay a hefty tax bill.
Public Service Loan Forgiveness (PSLF)
Those who qualify for Public Service Loan Forgiveness (PSLF) don’t have to worry about paying taxes on the amount forgiven. As long as you meet the eligibility requirements of working for a qualified employer and make 120 qualifying payments, you can have your loan balance(s) forgiven without a tax consequence.4
Borrowers who have worked for eligible employers and have either FFEL, Perkins Loans, or Direct Loans, need to submit a PSLF application by Oct. 31, 2022, to take advantage of a limited PSLF waiver that gives borrowers credit for pay periods that would normally not count toward the 120 qualifying payments they need to receive loan forgiveness.5
Income-Driven Repayment Forgiveness
Depending on the type of income-driven repayment plan, you might be eligible for loan forgiveness after 20 or 25 years. After being on an income-driven repayment plan for the required amount of time, the remaining balance is canceled; however, that cancellation ordinarily comes with a tax bill.6
Even though forgiveness for income-driven repayment is normally considered taxable, the COVID-19 relief bill passed in 2021 eliminated taxes for this type of forgiveness through 2025.7
As such, you could be on the hook for tens of thousands of dollars in taxes, depending on how much is ultimately forgiven.
Employer Student Loan Repayment Assistance and Taxes
Some employers offer benefits to their employees, helping them with their student loan payments. As with some types of student loan forgiveness, this form of aid is usually taxable. So if your employer offered up to $5,000 to help you repay your student loans during the year, it would be added to your taxable income. You would determine your taxes based on that total income.
However, as with income-driven repayment, COVID-19 relief has suspended the taxes on these amounts. Through 2025, if an employer offers student loan repayment assistance, you won’t be taxed on the amount provided.7
Congress could decide to make these tax provisions permanent, but it’s important to take advantage of them now, if you can, just in case Congress chooses not to act and you end up on the hook for taxes down the line.
Do My Student Loans Affect My Tax Return?
Yes. If you paid student loan interest, you can receive a tax deduction for that amount, up to $2,500. Additionally, some types of loan forgiveness are considered taxable income.18
Do Student Loans Count as Income on My Taxes?
Receiving a student loan to help pay for school isn’t considered income for tax purposes. Debt isn’t usually considered income by the Internal Revenue Service (IRS), although some types of debt forgiveness can be considered taxable income.8
Does COVID-19 Relief Impact My Student Loans and Taxes?
COVID-19 relief has changed the way student loans affect your taxes, at least temporarily. Forgiveness related to income-driven repayment isn’t considered taxable income through 2025. Additionally, as interest payments have been halted on federal student loans, you will likely be unable to take advantage of the student loan interest tax deduction.7
The Bottom Line
Your student loans can have an impact on your tax return. If you have paid interest on your student loans, you might be able to deduct a portion of that interest from your taxable income.
Additionally, some types of loan forgiveness come with tax consequences. Review your financial circumstances and consider speaking with a tax professional to find out what the tax benefits and consequences are regarding your student loans.
tax implications paying off someone elses student loans
There are a few tax implications to consider when paying off someone else’s student loans.
If you pay off a friend’s or family member’s student loans, it is probably a non-taxable gift to them. However, your friend or family member may be responsible for filing gift tax returns and for paying any applicable gift tax on the payment.
Let’s say that you decide to pay off $10,000 of your best friend’s student loans. That means that your friend will no longer have a liability for those funds because they’ve been paid off by someone else—you!
However, once your friend has received this payment, they will no longer be responsible for making payments on their loan. This means that they won’t be able to deduct interest payments from their taxes anymore (or claim them as credits). And if you made this payment as part of any kind of “giveback” agreement where there was some kind of expectation of repayment on your part? Then it could be considered income in disguise and taxed accordingly (which is why we recommend avoiding these kinds of arrangements altogether).
student loan interest deduction phase out 2020
As of January 1, 2020, the student loan interest deduction will be phased out for taxpayers who are married filing jointly with AGI between $140,000 and $170,000 ($70,000 and $85,000 for single filers). The deduction is unavailable for taxpayers with AGI of $170,000 ($85,000 for single filers) or more.
This means that if you have a student loan and your income is between $140,000 and $170,000 ($70,000 and $85,000 for single filers), you may not be able to take advantage of this deduction in 2020. If your income is above these thresholds but below the standard deduction amount ($12,200 for singles in 2019), then you may still be able to take advantage of this benefit.
For undergraduates, the student loan interest rate for Direct Unsubsidized and Subsidized loans is now 4.99%, and the rates are higher if you’re pursuing a graduate degree.
Understanding student loan interest is crucial to avoid taking on too much debt and to pay down what you owe.
This guide will show you how student loan interest is calculated, the different interest rates available, and provide tips to get the lowest possible rate on your loans.
How does student loan interest work?
Student loan interest rates are based on three main factors:
- The amount borrowed
- The type of loan
- The estimated time it takes to repay
Interest rates vary by lender, so borrowers should shop around and compare rates before taking out a loan.
You’ll get your interest rate when you apply for a federal or private student loan. This rate is the annual percentage rate (APR), which is the actual yearly cost, including interest and fees (but not compounding) for the loan term.
Federal student loans have fixed interest rates which Congress sets. Private student loans can have either a fixed or variable APR, and your lender determines your rate.
Check out the main differences in the table below:
| Fixed rate | Variable rate |
| Remains the same for the life of the loan. | Changes with its underlying market index. |
| Makes budgeting for payments easy. | Could rise or fall based on market rates. |
| Can change as often as every month, but typically changes every 6 – 12 months. |
Depending on whether interest accrues daily or monthly, the interest your loan generates is tacked onto your total balance each day or month.
The balance includes the principal (initial borrowed amount) and interest accrued. You must repay the interest before paying down the principal balance, so not paying makes your debt more expensive over time.
How do interest rates differ between federal and private student loans?
Interest rates are often lower on federal student loans than private student loans. Federal student loan interest rates are fixed for the whole loan period and may not exceed the maximum rates listed in the Higher Education Act of 1965:
- 8.25% – Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduates
- 9.50% – Direct Unsubsidized Loans for graduate or professional students
- 10.50% – Direct Parent PLUS loans
These are the maximum allowed rates for federal student loans, but often the rates are much lower. For example, federal student loan interest rates range from 4.99% to 7.54% for 2023.
Loans from private student lenders have no maximum limit, and variable interest rates can balloon to be much larger than the initial interest rate of your loan. In 2022, private student loan rates varied from 3.99% to 15.66%.
It may seem best to choose the loan with the lowest interest rate, but also consider the other terms of the loan. Variable interest rates may start out lower than fixed rates but are subject to change, which could increase your monthly payment.
More flexible repayment options are available for federal student loans, including income-based repayment plans and deferment. These options are not available for many private loans.
How often does student loan interest compound?
Compound interest is the addition of interest to the principal of a loan—interest on the interest. Most student loans accrue interest daily and compound daily or monthly.
Daily compounding means your APR applies to the interest that accrued the previous day. This is in addition to the rest of your principal amount.
Compared to monthly, daily compounded interest is less advantageous for you because the more often your interest compounds, the faster your debt will grow.
In most cases, student loan rates are advertised with yearly interest rates (APR), but the interest compounds daily. You can find out how often your interest accrues as well as your compounding rate on the promissory note for your student loans.
How to calculate student loan interest
Using the simple daily interest formula, you can calculate your interest the following way.
Begin by determining your interest rate factor using the following calculation:
Fixed interest rate of your loan / Number of days in a year = Interest rate factor
Then multiply the following:
Principal balance x Interest rate factor
Let’s assume you take out a $10,000 student loan with a 5% APR.
The interest rate factor is 0.0137% (0.05 / 365 = 0.000137).
Here’s what your interest would look like with daily compounding compared to monthly compounding:
| Daily compounding | Principal x Interest rate factor | Total principal + interest |
| Day 1 | $10,000 x 0.000137 | $10,001.37 |
| Day 2 | $10,001.37 x 0.000137 | $10,002.74 |
| Day 30 | $10,039.81 x 0.000137 | $10,041.18 |
In this example, $41.18 of interest has accrued in a month.
| Monthly compounding | |
| Principal x Interest rate factor x Number of days | Total principal + interest |
| $10,000 x 0.000137 x 30 | $10,041.10 |
Over a month, $41.10 of interest has accrued.
As you can see, daily compounding results in slightly higher interest charges over a month.
The difference will be insignificant if you make monthly payments that cover all the interest that has accrued that month.
But if you don’t keep up with your payments, the interest that accrues each day will continue to grow as the daily interest adds to your principal balance. It’s important to meet your repayment obligations on time and in full each month because it will help minimize your total debt burden over the long term.
When does student loan interest start accruing?
You will start accruing interest at different times depending on the type of loan you take out.
In some cases, interest begins accruing upon disbursement. This is always the case with private student loans and federal Direct Unsubsidized Loans. If you don’t make interest payments while in school, the interest will accrue throughout your years in college.
In the case of federal Direct Subsidized Loans, the federal government covers your accrued interest while you are in school and over a six-month grace period after you graduate. Once those six months are up, you are responsible for repaying the principal and the interest.
| Type of loan | Borrower type | Fixed interest rate (as of January 2023) | Start of interest accrual |
| Direct Subsidized Loans | Undergraduate | 4.99% | 6 months after graduation as long as you are enrolled at least half-time |
| Direct Unsubsidized Loans | Undergraduate | 4.99% | Upon loan disbursement |
| Direct Unsubsidized Loans | Graduate or Professional | 6.54% | Upon loan disbursement |
| Direct PLUS Loans | Parents and Graduate or Professional Students | 7.54% | Upon loan disbursement |
You don’t have to start paying student loan interest right away
Even for most unsubsidized loans, such as those from private lenders, you won’t have to start paying interest immediately. Many private companies allow for a grace period, which can be excellent news for students who can’t take on a job during college.
Under certain circumstances of financial hardship, such as a period of unemployment or reduced income, borrowers can work with their lenders to enter deferment or forbearance and temporarily freeze or decrease their monthly payments.
This action helps the borrower avoid default when money gets tight.
| Forbearance | Deferment | |
| Definition | Loan repayment relief that allows you to temporarily reduce or freeze payments on student loans if you are experiencing a financial hardship. | Temporary suspension or reduction of your monthly loan payments. |
| Difference | Interest continues to accrue and is added to your principal balance when your forbearance ends. | You will not have to make any principal payments on your loans. However, you must pay interest on Direct Unsubsidized, Direct PLUS, Federal Family Education Loan (FFEL) PLUS, the unsubsidized portion of Direct Consolidation, and the unsubsidized portion of FFEL Consolidation loans |
Regardless of these options for postponement, keep this in mind: Once you receive an unsubsidized loan, if you forgo payments through the six-month grace period after you leave school, you might already owe thousands more than you borrowed.
In this case, it will take several payments before you begin paying down the principal.
How to pay off the interest on student loans faster
The faster you pay off your student loan interest, the faster you can start paying off your principal balance, which will reduce your interest over time.
If you’re tired of paying interest on your loans, here are the steps to paying off your loans early.
Prioritize your loans
One way to pay off your student loans faster is to prioritize your loans by interest rate.
Once you’ve established your payment schedule with automatic payments of at least the minimum required amount, allocate any remaining resources to the loan with the highest rate.
You can see an example of this in table below:
| Example prioritization | |||
| Payoff order | Loan | Balance | Interest rate |
| 1 | Loan B | $10,000 | 7.80% |
| 2 | Loan C | $3,000 | 6.50% |
| 3 | Loan A | $5,000 | 4.99% |
Make extra payments
We recommend making extra payments whenever possible—especially if your interest compounds daily. A second monthly payment helps minimize the amount of time interest can accrue while you pay down the principal.
A smart way to handle this is to make a payment every time you get paid (if you get paid every two weeks). Your first paycheck can cover the interest you’ve accrued in the previous month, and the second will eat away at the principal and limit the interest that accrues in the subsequent month.
For example, if you were paying off a $10,000 loan at 7.8%, you’d have a monthly payment of about $120.
If you made two payments each month of $120, you would pay off your loan in four years instead of 10 and save $2,700 on interest:
| Current | 2 payments per month | Savings | |
| Repayment length | 10 years | 4 years | 6 years |
| Interest payments | $4,433 | $1,700 | $2,731 |
| Total cost | $14,433 | $11,700 | $2,731 |
Calculate how an extra payment could save money on your student loans with our student loan prepayment calculator.
Refinance
Refinancing student loans is another smart way to abate the pileup of interest. If you think you might qualify, apply for a loan with lower interest rates from a private company, or check whether you can refinance through a state-run program.
Be aware that refinancing federal student loans with a private lender will forfeit any borrower protections you get with federal loans, such as eligibility for income-driven repayment or the potential for student loan forgiveness.
Take a look at how refinancing a $10,000 student loan with an 8% interest rate to a loan with a 5% interest rate could lower your monthly payments by just $15 but save you more than $1,800 over the life of the loan:
| Current | Refinance | Savings | |
| Monthly payment | $121 | $106 | $15 per month |
| Term length | 10 years | 10 years | 0 months |
| Total interest | $4,559 | $2,728 | $1,831 |
| Total cost | $14,559 | $12,728 | $1,831 |
Calculate how refinancing your student loans could save you money with our student loan refinance calculator.
How can I lower my student loan interest rate?
Our additional tips for lowering student loan interest rates are as follows:
- Refinance: If you have good credit and a steady income, you can refinance your student loans with a private lender or through your state at a lower interest rate.
- Consolidate: Consolidate federal student loans into one monthly payment through the Department of Education’s Direct Loan Consolidation program.
- Autopay discounts: Many loan servicers reward borrowers for setting up automatic payment plans. Check with your lender to see what discounts are available.
- Get a cosigner: Having a parent or significant other with a high credit score attached to your loan can give a private lender peace of mind the money is in good hands, helping you qualify for a lower rate. Or if you have good credit but don’t make enough money to qualify for a lower interest rate, you can get a loan or refinance your loan with a cosigner who qualifies.
- Improve your credit score: Making on-time payments each month can help you improve your credit score and increase your odds of qualifying for a lower interest rate for new or refinanced loans.
These options offer a greater chance of paying down your student loan interest and then the principal sooner.
Do your best to keep on schedule, get ahead when you can with additional payments, and remain aware of what you owe.
If you need any more support in deciding how best to navigate your student loan situation, check out our in-depth guide on how to save money on student loans.
Leave a Reply