Five Things You Should Understand About Taxes and Your Student Loans
Student loans play a very large role in US higher education, with almost all students borrowing funds to pay for the increasing costs of a college degree. As loans make it easier for individuals to increase their knowledge in universities, society benefits by gaining an educated populace.
These student loans, however, are not always a ray of sunshine. As anyone experienced with debt knows, the black cloud of reality reemerges on the day when you finally have to pay back the loan.
Don’t fret, however! These loans provide tax benefits that help ease an individual’s debt burden. We break down the most important things you need to know by highlighting the 5 things you should understand about taxes and student loans:
1. Remember that your student loans don’t count as your income…
While you may feel richer with your student loans, they most certainly do not count as your income. As such, don’t put yourself at a disadvantage by listing your loans as income in your tax return. Otherwise, the IRS will be all too eager to increase your tax burden. Remember that an “income” generally increases your assets without increasing your liabilities. Hence, while you do gain more cash assets from your student loans, they are cancelled out by the fact that you also increase your liabilities.
2. …but they also don’t count as your expense.
While student loans aren’t income, they also aren’t expense. So if you take out a $20,000 loan this year and your income is $50,000, you cannot deduct the value of your loan and declare only $30,000 in taxable income. Note that the IRS usually monitors the income that individuals declare, so a significant drop would most likely put you under the radar. Once they find out you deducted your loan amount, not only will you have to pay the tax you should have paid, but you will also have to shell out fines and penalties!
3. The interest you pay may be deductible – use it!
If my student loans don’t count as income or expense, then what effect does it have in my taxes? The answer lies in the interest you pay. This is where the State shows its support for the public good that student loans bring.
As you pay back your student loan, you will likely receive what is called a Form 1098-E, which is simply a report on how much interest you paid for the year. Note, however, that not all this interest is deductible. The amount in your Form 1098-E is simply the starting point for the computation that the IRS prescribes in its rules. After you follow the step-by-step procedure, you then have to go through one last hoop: the interest ceiling. Remember that you are only allowed a maximum deduction of $2,500, so make it count!
Note as well that not everyone can have their interest deducted. If you are married filing separately or if your modified adjusted gross income is $75,000 or more ($155,000 if married), you cannot deduct any loan interest.
4. Your tuition fees may further increase your deductions.
Related to student loans are the tuition fees you pay, which are also deductible in your tax return. For example, if your college tuition costs are $10,000 for this year, you will be eligible to deduct $4,000 from your income, which will result in a $1,000 decrease in your taxes, depending on the tax bracket you are in. Note that these deductions are independent of your student loans, so they are available even if you don’t have borrowings.
5. Be wary of loan forgiveness
While the best news for a college student may be to hear that his loan has been forgiven, be wary as you will most likely be assessed taxes by the IRS. Remember that student loans generally are not “income” as they increase both assets and liabilities. But if the loan is forgiven, then it simply acts as a free asset to the borrower and, as a result, is taxable.
While there are ways to minimize these taxes, it’s best to discuss these with an experienced accountant in order to get the best bang for your buck. Otherwise, the money you saved from getting the loan forgiven may be offset by the penalties and headaches you get from the IRS.
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