How to Look Up Your AGI

Finding your AGI is straightforward and there are a few options to locate the exact number:

1. 1040 Form: On the standard 1040 tax form, your AGI is listed on Line 11.
2. 1040-SR Form: If you use the 1040-SR form, designed for seniors, your AGI is on Line 11.
3. IRS Website: If you don’t have access to your physical tax documents, you can look up your AGI on the IRS website. Log into your account on IRS.gov, navigate to the “Tax Records” section, and you’ll find your AGI on your most recent tax return.

Understanding Adjusted Gross Income (AGI)

AGI is your gross income after specific adjustments, also known as “above-the-line” deductions. It includes your total income from wages, dividends, capital gains, business income, and other sources, minus allowable deductions like student loan interest, retirement plan contributions, and tuition fees.

Difference Between AGI and Annual Salary:

• Annual Salary: This is your total income before any deductions.
• AGI: This is your income after accounting for allowable adjustments. It’s typically lower than your annual salary due to these deductions.

To be clear, Adjusted Gross Income isn’t something that is used just for student loans. Instead, it is a critical figure during tax season. AGI is essential for determining eligibility for various tax credits and deductions, in addition to calculating your tax bill.

AGI for Married Couples

For married couples, understanding how AGI works is vital, especially when estimating student loan payments:

• Joint Filers: Couples who file jointly will have a shared AGI, which includes the combined income and deductions of both spouses.
• Separate Filers: Couples who file separately will have independent AGIs, meaning each spouse’s AGI is calculated based on their individual income and deductions.

When estimating student loan payments, using AGI is the best way to get an accurate picture of payments on various repayment plans. If your AGI includes your spouse’s income, it means you filed jointly and your spouse’s income will be factored into your student loan payment. If you file seperately, your spouse’s income is not included in your AGI and it does not impact your student loan payments.

For this reason, many married student loan borrowers elect to file their taxes separately.

Keeping AGI Down to Lower Student Loan Payments

Keeping your AGI as low as possible can result in lower monthly payments for those on income-driven repayment plans like SAVE. Here are some strategies:

• Above-the-Line Deductions: These deductions lower your AGI and include contributions to certain retirement plans, student loan interest, tuition fees, and health savings account (HSA) contributions.
• Below-the-Line Deductions: These deductions, such as standard or itemized deductions, do not affect your AGI.

Examples of Deductions That Lower AGI

1. 401(k) Contributions: Money contributed to a 401(k) retirement plan reduces your taxable income and thus your AGI.
2. Traditional IRA Contributions: Putting money in an IRA will also lower yoru AGI. (Note: Roth IRA contributions do not reduce AGI.)
3. Health Savings Account (HSA): Contributions to an HSA are deductible, lowering your AGI.
4. Student Loan Interest: Up to $2,500 of student loan interest can be deducted, reducing your AGI.

To dig deeper, check out this article for more detailed strategies on how to lower your AGI to reduce student loan payments.

By understanding and managing your AGI, you can better control your student loan payments and take advantage of income-driven repayment plans to reduce your financial burden and get more student debt forgiven.

The post Adjusted Gross Income (AGI) and Your Student Loans appeared first on The Student Loan Sherpa.

This article will cover everything from the student loan interest deduction to advanced strategies for lowering payments and tax bills and increasing retirement accounts.

The Student Loan Interest Deduction on 2023 Tax Returns

Student loan borrowers can claim a deduction of up to $2,500 on their 2023 tax returns. The IRS bases this deduction on the amount spent on student loan interest payments. This deduction applies to both private and federal student loans. However, money spent paying down the principal balance isn’t counted towards this deduction. Your lender should send a 1098-E tax document with an exact accounting of the money spent on student loan interest.

Note: Lenders are only required to supply a 1098-E for borrowers who pay over $600 in interest. If you spent less or have small loans with various lenders, you can still deduct that amount. Just be aware that you might have to contact your lender for documentation.

For further information, including income limits and phase out, be sure to jump down to the student loan interest deduction FAQ.

If you have concerns about whether or not your student loan interest is an eligible deduction, the IRS has a comprehensive tool for determining if you qualify.

Timing Income Certifications During 2024

Student loan borrowers on income-driven repayment plans must certify their income every year. Most borrowers certify by supplying the Department of Education with their most recent tax return.

Those who are about to start or recertify an income-driven repayment plan may want to consider the timing of their application. Those who earned less in 2022 than in 2023 would benefit from applying for income-driven repayment before filing 2023 tax returns. This way, the income-driven repayment plan application will result in lower monthly payments.

Borrowers already enrolled should investigate and make a mental note of when they next need to certify their income. Missing the income certification deadlines can be expensive, so tax time is a great time to verify that everything is in order.

Student Loan Checkup

Filing taxes requires many student loan borrowers to spend a little time on the websites of their various lenders. During this time, a quick checkup can be a great way to catch any potential issues.

Borrowers should review the following:

Loan Balances – When checking loan balances, it is beneficial to review recent payments. Check to see how much went to interest versus the principal. Borrowers who have the bulk of their payments going towards interest should consider paying extra to accelerate repayment or investigate ways to get a lower interest rate.

Automatic Payment Settings – Automatic payments can be a hassle, but they often qualify for a .25% interest rate reduction. The rate reduction isn’t huge, but it is something. Make sure you have the correct amount withdrawn. Also, verify that it is coming out of the correct bank account.

Look for Late Fees – Lenders are experts at adding fees whenever possible. Check recent payments to make sure your lenders didn’t charge any fees. If they did, call to dispute the fees and/or find ways to avoid future charges.

Check Interest Rates – Many private student loans have variable interest rates. Because interest rates are currently rising, it’s essential to check on the potential movement of your student loan interest rates. If your interest rate has jumped, consider switching to a fixed-rate loan with a student loan refinance company like Splash or ELFI.

Educational Tax Credits

There are a couple of tax credits available for students and parents of students. These credits are called the American Opportunity Credit (formerly The Hope Credit) and the Lifetime Learning Credit.

The American Opportunity Credit offers up to $2,500 in partially refundable credits. The Lifetime Learning Credit provides up to $2,000 in nonrefundable credits. However, only those enrolled in an eligible educational institution can qualify for these credits. The educational institution should send out a 1098-T to aid in figuring out your credit.

The IRS has a detailed breakdown comparing these credits. The IRS also has a very useful Q and A explaining the educational tax credits. Current students and their parents will want to pay close attention.

Take Advantage of Retirement Contributions

The more money you put into your traditional IRA or 401(k), the less you’ll be required to pay if you’re on a federal income-driven repayment plan such as IBR, PAYE, SAVE, or ICR.

The IRS provides some flexibility about which tax year your contributions can be applied towards the income tax deduction. In other words, you can use IRA contributions made 1/1/2024 through 4/15/2024 towards the 2023 tax year or the 2024 tax year. Just make sure you don’t make the mistake of trying to count the payment towards both years.

Traditional IRAs and 401(k)s are not the only accounts you can use to lower student loan payments. For example, many retirement plans for government employees, like 457 plans, also count. Those who have HSAs (Health Savings Accounts) can also make contributions that will lower their required student loan payment.

This tactic of shielding income from counting towards student loan payments can be especially useful for borrowers working towards federal student loan forgiveness programs.

By making this move, student loan borrowers can:

1. Lower their tax bill,
2. Save extra money for retirement,
3. Lower their student loan bill for the next year, and
4. Increase the amount of student debt that is forgiven.

Saving for retirement may not seem like much of a priority when you are facing a mountain of student debt, but the sooner you start saving for retirement, the better. Plus, this strategy is a good way to accomplish multiple goals with one move.

Tax Time is Employer Certification Form Time

Employment certification forms are essential in tracking progress towards Public Service Loan Forgiveness (PSLF).

There isn’t a requirement to submit your employer certification form at tax time, but it is an excellent habit to get started. Yearly submission of these forms is the best way to ensure that you are meeting the requirements for PSLF. By making employer certification forms part of your annual tax routine, you ensure that this critical step doesn’t get skipped over.

Due to confusion regarding employer certifications and PSLF in general, the Department of Education created the PSLF Help Tool. Borrowers can use this tool to determine employer eligibility and generate the proper form to certify employment.

Should Student Loan Borrowers File 2023 Tax Returns Jointly or Married Filing Separately?

The biggest and most challenging question for married couples with student loans at tax time is whether or not to file as a couple.

The crux of the issue boils down to a simple problem:

• File separately, and income-driven repayment calculations are based upon one income rather than two, BUT
• Filing separately results in a larger tax bill.

This calculation can be quite tricky, especially when you factor in all the other strategies at play during tax time.

We do have several tips that can help couples facing this dilemma.

• Calculate taxes both ways – The only thing more miserable than doing taxes once is doing them multiple times. However, the only way to find out the cost of filing separately is to do the math for both routes. If you have an accountant or tax prep service, they should be able to tell you the difference in cost.
• Estimate the monthly student loan savings – The Department of Education has a very useful Student Loan Repayment Simulator. The total spending figures that it generates leave a little to be desired, but the monthly payment estimation is quite good. This will help calculate the benefit of filing separately.
• The math is easy for couples who both have federal loans – Couples who both have federal student loans and are both on an income-driven repayment plan may be better off filing jointly. Many fear that by filing as a couple, their payments will double, but that is not the case.
• Remember the student loan interest deduction – Couples that file as married filing separately are not eligible for the student loan interest deduction. The value of this deduction can be pretty small due to its many limitations, but it might be enough to change the math.

Borrowers should also keep in mind that while lower payments on their student loans are desirable, the goal is to eliminate the debt. Even if you get lower IBR payments for the next year, it just means more spending on interest before the loan is paid off. The math changes for those pursuing forgiveness. But, it doesn’t make sense for many borrowers to pay extra in taxes to prolong paying off student loans.

If you want to get creative with your taxes for student loan purposes, we think most couples would benefit more in the long run by filing jointly and lowering their income via retirement contributions rather than filing separately.

Student Loan Interest Deduction FAQ

One Final Tax Tip for Student Loan Borrowers Filing Their 2023 Tax Return

The idea of spending extra time messing with your finances during tax time may not seem appealing. Just getting taxes filed is already a pain.

However, putting in a little extra effort to take advantage of opportunities for student loan borrowers can save a bunch of money and save the time of having to do things twice.

The post 2023 Tax Return Strategy, Tips & Deductions for Student Loan Borrowers appeared first on The Student Loan Sherpa.

Many couples fear that their student loan payments will double if they get married. This is not the case.

Your payments will almost certainly change if you get married, but the change depends upon several details.

A Note from the Sherpa: This article was initially written in the early days of this site. It has since been updated numerous times to include up-to-date information, including the new SAVE plan.

The Rules for Couples on Income-Driven Repayment Plans

I usually don’t like to dwell on the research that goes into each article, but given that there is so much contradictory information on this topic, it is probably prudent.

Like any student loan issue, it starts with a call to the student loan servicer. When I asked about how marriage would affect my student loan payment, I proposed the following hypothetical. Suppose my spouse and I each make $40,000 per year, both have student loans, and both are on IBR. Will our payments be the same as two single people making $40,000 per year, or will they be double? I was told confidently (and incorrectly) that our payments would be doubled.

Because I was reasonably confident that the provided information was incorrect, I politely went through several other hypotheticals with my lender. Eventually, the customer service representative changed her answer. She explained that if we both were on IBR before marriage and got married, our total payments should remain the same. She based this response on the Income-Driven Repayment application form. This particularly clever customer service representative noticed that you could submit information about your spouse’s federal student debt. They wouldn’t ask for this information if it didn’t count. Thus, she concluded that her initial answer was wrong and that payments would not double if two IBR borrowers got married.

Not fully satisfied with this answer, I turned to Google for further help based on the information from my lender. A bit of legal research followed. Eventually, I found the definitive answer in the Code of Federal Regulations, specifically, 34 CFR 685.221(b)(2)(ii), which states that when calculating IBR payments:

The Secretary adjusts the calculated monthly payment if—Both the borrower and borrower’s spouse have eligible loans and filed a joint Federal tax return, in which case the Secretary determines—

(A) Each borrower’s percentage of the couple’s total eligible loan debt;
(B) The adjusted monthly payment for each borrower by multiplying the calculated payment by the percentage determined in paragraph (b)(2)(ii)(A) of this section; and
(C) If the borrower’s loans are held by multiple holders, the borrower’s adjusted monthly Direct Loan payment by multiplying the payment determined in paragraph (b)(2)(ii)(B) of this section by the percentage of the total outstanding principal amount of the borrower’s eligible loans that are Direct Loans;

Similar language for PAYE can be found at 34 CFR § 685.209(a)(2)(ii)(B).

This legal jargon basically says that the total IDR payment is calculated for the couple. Individual payments are then based on the portion of the debt in the name of that particular spouse. So if your spouse has twice the student debt you do, if you both are on the same IDR plan, her payment will be double yours.

Calculating Monthly Payments

One of the best tools for calculating monthly payments is the Department of Education’s Loan Simulator. Couples can add both their incomes and student loans to get an accurate projection of monthly payments.

For those who want to understand how the calculations are made, the Department of Education is first looking at the combined adjusted gross income (AGI) of the couple from their most recent tax return. From that number, the Department will calculate the discretionary income of the couple. Depending upon the Income-Driven Repayment plan selected, the couple will be responsible for paying 10, 15, or 20% of their discretionary income towards their federal student debt. (Up to this point, the process for single individuals and couples is the same.)

When couples both have federal student loans, the payment is split proportionally to how much each partner has borrowed. The spouse who borrowed more will be the one with the higher payments.

How Married Couples Pay More on IBR, PAYE, and SAVE

Now, things get complicated.

Even though the double payment concern doesn’t exist, it is still possible that payments will go up.

The increase can be traced back to the discretionary income math. Loan payments are based upon discretionary income, defined as earnings above 150% of the federal poverty level. (Note: SAVE uses a more generous 225% of the poverty guidelines.)

A quick example of payment calculations will help illustrate the issue. Suppose I earn $44,000 annually, and the federal poverty guidelines say that 150% of the poverty level is $20,000. My discretionary income is  $24,000 per year or $2,000 per month. If I were on PAYE, 10% of my monthly discretionary income would be $200. Thus, I pay $200 per month on PAYE.

For couples who both have student loans, filing jointly or separately impacts the amount of money that you keep each year before you have to make payments. If you file separately, you get to keep that first $20,000, and your payments are based upon the rest. Your spouse also keeps the first $20,000, making payments based on the additional income. By filing separately, you EACH get to keep that first bit of income.

If you file jointly as a couple, you only get to keep that first bit of income once. If your combined income is $90,000, you subtract that $20,000 from the poverty guidelines once, leaving $70,000 of discretionary income. Because of this distinction, a couple will pay slightly more if they file jointly.

For many couples, the slight increase may not offset the downsides of filing separately. However, the only way to know for sure is to do the math on filing jointly and filing separately. Between tax programs that quickly estimate your tax bill and the Department of Education Loan Simulator, comparing the two options isn’t difficult.

Special Rules for REPAYE and SAVE

At one point, the REPAYE plan had special rules for married couples who filed separately. In most cases, borrowers still had to include their spousal income, even though they filed separately. For this reason, many married borrowers were encouraged to stick with PAYE or IBR.

With the creation of the new SAVE plan, the old REPAYE rules were eliminated. This is excellent news for married borrowers who want to take advantage of the new SAVE plan.

Now, spousal income is treated the same for all IDR plans. If you file separately, you can exclude your spouse’s income from your loans. If you file jointly, payments are based on your combined income.

When Married Couples Who Both Have Student Loans Should File Separately

Adding kids to the equation can change the math.

As one reader noted in the comments, being in a family of four means that the poverty guideline number is much higher than it would be for just two. Filing separately and being able to subtract that number twice can make a big difference.

The larger your family, the bigger the potential savings from filing separately, even if you both have student loans.

The Short and Simple Answers for IBR, PAYE, and SAVE Couples Who Both Have Student Loans

• Filing taxes jointly does not mean your student loan payments will double.
• Filing taxes jointly does mean that your monthly payments will be somewhat higher.
• If you have a larger family, the IBR and PAYE benefit of filing separately goes up.
• Borrowers should compare the potential savings of filing separately against the higher taxed bill caused by filing separately.

Finally, I’d also like to point out that getting a low IBR or PAYE payment is not the goal of federal student loan borrowers. The goal is to eliminate the debt. For borrowers chasing after student loan forgiveness, the lower payments are valuable. If you will eventually pay the debt off in full, lower monthly payments just mean the loan will cost more in the long run.

The post IBR, PAYE and SAVE for Married Couples who Both Have Student Loans appeared first on The Student Loan Sherpa.

The good news is that this daunting tax bill is often avoidable.

Unfortunately, not every borrower will be able to sidestep the student loan tax bomb. It remains a significant drawback of pursuing loan forgiveness and is an important factor for any borrower considering this option. Thus, it’s crucial to understand the potential financial impact of this tax liability and plan accordingly.

Student Loan Tax Bomb Origins

The student loan tax bomb originates from a specific tax rule that requires forgiven debt to be taxed as income in the year it was forgiven.

This rule often makes sense in various contexts. For example, if you work for Visa and Visa forgives some of your credit card debt as a bonus, it’s reasonable to tax that forgiven debt as income. This prevents companies from exploiting loopholes by issuing “loans” to employees and then “forgiving” them as a way to avoid paying taxes.

Treating forgiven student loans as taxable income follows the same logic, ensuring fairness in the tax system. Regrettably, the tax bomb creates a financial challenge for the student loan borrowers receiving the forgiveness. Student loan borrowers should, therefore, prepare themselves to overcome that hurdle.

Student Loan Forgiveness Isn’t Taxed – For Now

Currently, student loan forgiveness is a notable exception to the rule taxing forgiven debt.

Sadly, this particular exception ends on January 1, 2026 for many types of student loan forgiveness. In other words, if you reach IDR forgiveness before 2026, you are in the clear. If you are making payments on the SAVE plan until 2029, there could be a large tax bill in your future.

PSLF Special Exception: Unlike IDR forgiveness, PSLF tax-free forgiveness is permanently written into the tax code.

If you expect to earn PSLF forgiveness in 2030, there won’t be a huge tax bill waiting.

The Rules After 2026 and Planning for the Worst

Starting January 1, 2026, the temporary rules excluding most forgiven student loan debt from taxable income will expire. At that point, the student loan tax bomb will be in play again.

While 2026 may seem distant, it’s important to note that many borrowers do not expect to earn forgiveness until after this date. Therefore, it is crucial to prepare for the possibility of a large tax bill.

As a borrower who doesn’t expect to earn debt relief until after 2026, I’m using a Roth IRA to plan for my tax bill. This approach allows me to save money in a tax-advantaged account. If I end up with a tax bill, I’ll have the funds set aside and ready to go. If I get lucky and Congress passes more legislation that exempts my debt forgiveness from taxable income, I will have saved extra money for retirement.

For those looking for a simpler option, a high-yield savings account can also be a good strategy. Any money saved for a potential tax bill can earn a decent return, growing over time.

The Rules on Debt Cancellation Should Change

Student loans have indeed become a politically charged topic. Yet, there appears to be bipartisan agreement on certain aspects, such as the taxation of loan forgiveness. The temporary rule that prevents the taxation of forgiven loans until 2026 wouldn’t have passed without support from both parties.

One compelling argument against taxing forgiven debt comes from parents with Parent PLUS loans. Under the rules for these loans, if the child for whom the loan was taken out passes away, the remaining debt is forgiven. However, prior to the change in tax rules, these parents faced substantial tax bills on the forgiven amounts—an outcome that was both tragic and widely regarded as unfair.

While predicting political outcomes is inherently challenging, the bipartisan support for the temporary tax relief measure suggests a growing recognition of the unfair burden placed on individuals in already difficult situations. Given this, there’s reason to hope that Congress might eventually eliminate the tax on forgiven student loans permanently, offering significant relief to borrowers.

How to Calculate Your Student Loan Forgiveness Tax Bill

Projecting a potential student loan forgiveness tax bill is tricky business. There are a number of uncertainties that make accurate forecasting difficult.

For starters, we don’t even know if this tax will exist by the time many borrowers qualify for forgiveness. Even if we prepare for the worst-case scenario in which the tax remains in place, predicting future personal income levels and tax brackets is nearly impossible.

In 2023, tax rates ranged from 10% to 37%. To illustrate what this means, here is an example. If you received $1,000 in forgiveness in 2030, and the tax rates remained the same, this would result in adding between $100 and $370 to your tax bill. The borrowers with the largest loan balances could be looking at tax bills of over $200,000!

State Taxes on Federal Loan Forgiveness

Federal taxes aren’t the only issue that borrowers need to consider when planning for the financial impact of loan forgiveness. State taxes may also play a role in the overall financial effects of loan forgiveness.

Many states align their tax policies with the IRS regarding loan forgiveness. In these states, there is no tax — at least until the federal exemption expires in 2026. At that point, these states may tax forgiven debt unless the legislature makes further changes.

Some states have their own rules for determining taxable income and do not follow IRS guidelines for forgiven debts. Some of them currently do tax forgiven debt while other states are considering following suit. For example, in 2023, Indiana, North Carolina, and Mississippi included student loan forgiveness as taxable income. Thus, even if Congress permanently excluded this income from tax, your state could still have different ideas about its taxability.

Because of these varying state tax implications, some borrowers who qualify for student loan forgiveness may find themselves in a position where accepting the forgiveness isn’t financially beneficial. In extreme cases, the tax bill could be so high that opting out of forgiveness becomes the more viable option. Borrowers should carefully assess their individual tax situations—considering both federal and state implications—to make the most informed decision about pursuing student loan forgiveness.

Tax Rules to Avoid the Massive Bill

As previously mentioned, the general rule is that forgiven debt is taxable income unless Congress has specifically excluded it. The IRS provides some additional reasons why taxpayers can still exclude forgiven debt from taxable income. The main exclusion that might be helpful to student loan borrowers is regarding insolvency.

In essence, the rule is that the taxpayer can exclude forgiven debt to the extent that the taxpayer was insolvent immediately before the forgiveness. What this means is that if the taxpayer’s total liabilities exceeded their total assets at the time of forgiveness, the taxpayer can exclude some or all of the forgiven debt from taxable income.

Some states may offer a similar exemption. However, the rules can vary widely, and not all states align with federal rules on this matter.

For those considering this as part of their financial strategy, it’s essential to approach with caution. Planning for the worst while hoping for the best is advisable. Don’t assume you can avoid the tax via the insolvency exception until you get the green light from an accountant. This careful approach ensures that you’re fully prepared for any tax implications that may arise and can plan accordingly.

The IRS provides Low Income Tax Clinics for those who qualify.

Sherpa Tip: Because there are federal and state tax laws to consider, it is an excellent idea to talk with an accountant if you are nearing forgiveness.

A good accountant can help you understand the latest tax law developments and minimize the tax bill.

If you have a large amount of debt that is about to be forgiven, speaking with an accountant could be money very well spent.

Minimizing the IDR Forgiveness Tax Bill

The more debt that gets forgiven, the harsher the tax consequences can be.

For borrowers who have substantial balances and are making lower monthly payments under an IDR plan, their balance might actually be increasing each month if their payments don’t cover all of the accruing interest.

In this circumstance, the new SAVE plan offers an excellent option to keep down the tax bill. On the SAVE plan, borrowers receive a generous subsidy that helps prevent the loan balance from growing.

This is particularly advantageous for those who qualify for $0 per month payments. They have an effective interest rate of 0% on the SAVE plan.

By keeping the balance stable or even reducing it, the SAVE plan helps ensure that when borrowers eventually qualify for forgiveness, the total amount forgiven—and consequently, the potential tax bill—will be more manageable.

All IDR borrowers should investigate the new SAVE plan, estimate potential monthly payments, and sign up when appropriate.

The post The Guide to IDR Forgiveness and the Future Tax Bills appeared first on The Student Loan Sherpa.

In the coming months, millions more will benefit from student loan forgiveness programs.

Among all of the good news, there is a growing concern about tax bills. Does student loan forgiveness get taxed? Are refunds from lenders taxable?

Spoiler Alert: In most cases, both the forgiveness and the refunds are tax-free.

Student Loan Refunds: Highly Unlikely to Get Taxed

To understand this concept, let’s be crystal clear about what it means to get a refund: A refund is an overpayment of a bill or debt.

For example, suppose you accidentally paid your credit card company $500 when your bill was only $50. When you get that $450 put back in your checking account, there isn’t any tax liability. A refund on an overpayment of a student loan is the same thing.

Sherpa Clarification: The title of this section says that refunds are “highly unlikely to get taxed” instead of plainly saying they don’t get taxed. My phrasing here is partly a lawyer thing: by qualifying my language, I won’t be wrong if someone gets taxed on a refund.

However, the primary reason for using terms like probably and usually is that there isn’t a uniform set of tax laws. There are federal taxes, state taxes, and local taxes. Within each jurisdiction, there can be some crazy rules.

Where I can, I’ll point out where some states might behave differently than the majority. However, analyzing every state and locality isn’t practical or useful.

PSLF Forgiveness: Not Taxed at Federal Level, States Vary

First, the good news on Public Service Loan Forgiveness: by statute, the federal government does not tax PSLF forgiveness.

States are a different story.

However, the news on this front is still mostly good. Some states don’t have an income tax. In these states, there isn’t a tax bill from PSLF. Likewise, many states follow the federal government in defining income. In these states, PSLF isn’t taxed.

Sadly, in a handful of states, taxes may become an issue.

An interesting component in this analysis is that state laws are rapidly changing. Some states are passing emergency legislation to remove a tax liability on loan forgiveness, while others are passing legislation to tax forgiveness. The best way to find out up-to-date tax rules in your state is to simply Google “PSLF Tax [your state].”

Biden Forgiveness: Not Taxed at Federal Level, Some States Tax

The Biden adminstration previously tried to cancel $10,000 per student loan borrower, the will be adjusting IDR payment counts to forgive debt for many more borrowers, and they are attempting another round of forgiveness for some borrowers.

These forms of forgiveness are all different, but they all are called Biden forgiveness by some borrowers and the tax rules for each type are identical.

Through 2025, there isn’t a federal tax on student loan forgiveness. However, as things stand now, the tax bomb is set to return in 2026. This will require some planning for borrowers on IDR plans, but those who get forgiveness before 2026 won’t have to worry.

At the state level, it’s possible that a state that doesn’t tax PSLF might still tax the one-time forgiveness. As things stand right now, that is the rule in Indiana, and it appears unlikely to change.

If you live in North Carolina, Indiana, Mississippi, Arkansas, or Wisconsin, you may have to pay a tax on one-time forgiveness. However, your state may change its rules moving forward.

What about payments made for others or by others?

Another tax concern for student loan borrowers comes in the form of student loan repayment help.

Suppose a family member is generous enough to pay off some or all of your student debt. Does that help get taxed?

The good news for borrowers is that this help falls into the category of gift taxes. For the recipient of the gift, there isn’t a tax bill. However, the gift-giver may have to pay a gift tax.

In the case of student loans and gift taxes, there are several exceptions that can help most people completely avoid a tax bill.

The post Student Loan Forgiveness and Refunds: What Gets Taxed appeared first on The Student Loan Sherpa.

Couples who live in community property states can get lower monthly payments by signing up for IBR, PAYE, or SAVE and filing their taxes separately. However, the process can be confusing, and federal loan servicers do not make it easy.

Optimizing income-driven repayment in a community property state requires some tax considerations, math, and navigating red tape.

The Advantage of “Married Filing Separately”

One of the major downsides to the federal Income-Driven Repayment (IDR) plans is the calculation of income for married couples.

The purpose of income-driven repayment is to allow borrowers to make payments based on what they can afford rather than what they owe. Borrowers can choose from one of several Income-Driven plans that charge 5, 10, 15, or 20% of the borrower’s discretionary income.

Many couples are often upset to learn that discretionary income calculations are based upon a couple’s combined income. This means that marriage can result in significantly larger payments.

These higher payments can be avoided if the couple files their taxes as Married Filing Separately. Borrowers on Income-Based Repayment (IBR), Pay As You Earn (PAYE), Saving on A Valuable Education (SAVE) and Income-Contingent Repayment (ICR) can exclude their spouse’s income from calculations by filing separately. The old exception to this rule was the Revised Pay As You Earn (REPAYE) plan, but this plan was replaced with SAVE and no longer has strict rules for couples.

While filing separately can mean lower student loan payments, it also potentially means a larger tax bill. The tax brackets look much different for married couples and single filers.

Couples will have to decide if the lower student loan payment justifies the higher tax payment each April.

Note for Couples who both have federal loans:
The benefit of filing separately is greatly reduced. As couples have more children, the benefit of filing separately increases.

Student Loans in Community Property States

The United States has nine community property states. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska also has an optional community property system.

In community property states, assets acquired by the couple are presumed to be jointly owned. This policy affects student loan borrowers who try to file taxes separately to secure lower student loan payments. Rather than listing individual income on a married filing separately tax return, taxpayers have to report 1/2 the combined income of the couple on the tax return. This policy can have a significant impact on the potential savings from filing separately.

If the husband has federal student loans and an income of $50,000 per year, it might make sense to file separately from his wife, who earns $100,000 per year. In most states, by filing separately, the husband would have his student loan payments calculated based upon that $50,000 in income. In a community property state, the husband’s monthly student loan payment would be based upon an income of $75,000. In this example, the couple would be better off if they didn’t live in a community property state.

The good news for couples living in community property states is that there is one way around the jointly owned property issue…

Avoiding Using Spousal Income in Community Property States

If your most recent tax return does not accurately reflect your income, borrowers are allowed to provide alternative documentation of income. Typically, the alternative documentation is a recent paystub. However, borrowers may also provide their servicer a letter in more complicated situations.

The significance for borrowers in a community property state is that it is possible to avoid using 1/2 your combined income as the starting point for payment calculations.

In other words, there is a procedure for couples in community property states to exclude spousal income from IBR calculations.

Borrowers need to do the following:

• File taxes separately,
• Apply for income-driven repayment using alternative documentation of income, and;
• Provide recent paychecks instead of a tax return.

Thus, to treat federal borrowers in community property states the same as borrowers in non-community property states, the Department of Education allows alternative documentation of income to get around the AGI calculation rules in community property states.

Final Thought on Filing Separately

Couples in community property states don’t have it easy, but they can file taxes separately to get a lower monthly payment on an Income-Driven Repayment plan.

However, just because something can be done doesn’t mean it should be done. Filing separately means a bigger tax bill. It also means a yearly hassle documenting income. The bigger tax bill and extra work doesn’t mean a smaller student loan balance; it just means lower monthly payments.

Borrowers working towards Public Service Loan Forgiveness may find that they come out ahead by going this route. Couples without a plan who want lower monthly payments may find that they end up spending more in the long run. In most cases, the debt will have to be paid in full and getting lower monthly payments will only delay repayment… not avoid it.

The post IBR, PAYE, and SAVE Strategy in Community Property States appeared first on The Student Loan Sherpa.

Obviously, I’m not 100% certain about this prediction, but things are definitely trending in the right direction for borrowers.

I’m putting my track record of accurate student loan predictions on the line and saying that the tax bomb won’t become a reality.

Why a Huge Student Loan Tax Bill is Unlikely for ICR, IBR, PAYE, and SAVE Borrowers

During the COVID-19 pandemic, Congress passed a law containing a provision that eliminates the tax on forgiven student debt until 2026. For the borrowers who will earn Income-Driven Forgiveness in the next few years, there is nothing to predict — there will be no tax bomb.

Unfortunately, most borrowers currently on the IDR plans will not qualify for forgiveness by the December 31st, 2025, expiration. One noteworthy aspect of the recently passed provision is that it eliminates the tax from the first borrowers earning forgiveness.

Additionally, this isn’t the first time Congress eliminated a tax on student loan forgiveness or cancellation. A couple of years ago, Congress removed the harsh tax on student loans forgiven due to death or disability discharge. Like the recent legislation, the provision ends December 31st, 2025.

The message from Congress is clear: student loan borrowers who have their debt discharged should not pay tax on the forgiveness.

Supporting the Student Loan Tax Bomb Would Be Dumb Politically

Stepping back from what the rules should be or what is fair, let’s look at the politics.

Calling for a huge tax bill for someone who spent at least 20 years making student loan payments looks bad. Democrats have strongly advocated for student loan cancellation and further help for borrowers. Republicans have built their brand on tax opposition.

When this issue comes up for debate again, eliminating the tax should get bipartisan support. Democrats need to stick up for student loan borrowers to get elected. Republicans need to oppose tax increases to get elected. Preventing a tax increase on student loan borrowers should be an easy sale.

Even though there is a huge debate about student loan cancellation, there hasn’t been a debate on these tax issues. Most advocates and experts argue that the tax bomb is a bad policy, and there has been little opposition.

Taxing Forgiveness is Bad Policy in this Case

The general rule of the IRS on taxing forgiven debt makes sense. Suppose my employer loans me $1,000. When you borrow money, there is no tax paid by the lender or the borrower. Instead of giving me a raise or a bonus, my employer cancels my debt. You can see how easy it would be to use a strategy like this to avoid taxes if there wasn’t a rule taxing canceled debt.

Applying this rule to student loan forgiveness and cancellation doesn’t make sense. If I qualify for IDR forgiveness, it is because I’ve been on an income-driven repayment plan for 20 years. I’ve made 20 years’ worth of payments, and I’ve paid interest on the debt. Presumably, I’ve been on this plan because I can’t afford to pay off my student loans under the standard 10-year plan. In this situation, student debt has been a financial hardship, and I’ve gone to great lengths to do what I can to make payments.

A huge tax bill in that situation is wrong. For starters, many borrowers who face the tax bomb probably can’t afford the bill. Secondly, it isn’t forgiving the debt if you are just turning it into an IRS bill.

My Big Hesitation in Predicting the Elimination of the Student Loan Tax Bomb

For years, when I discussed student loan issues, I only made suggestions based upon the current status of the law. This approach was safe and it was easier.

However, my inbox was full of emails from readers asking about what might happen and how to plan for various possibilities. It is smart to plan for various contingencies, and to the extent I can offer insight on a topic, I try to do so.

In the case of the student loan tax bomb, I still think borrowers should prepare as though it will happen. As a student loan borrower myself, I’m making preparations for a huge tax bill. My plan incorporates the fact that I think I probably won’t face this bill. Even though I don’t expect the tax to happen, I’m not going to bet on Congress doing the right thing or the smart thing. I have a backup plan in place, and I think every borrower should do the same.

Please don’t assume Congress won’t tax forgiveness. Get ready for a tax bill, and when Congress eliminates the tax, enjoy the fruits of your labor.

The post Why This Expert Thinks the Student Loan Tax Bomb Probably Won’t Happen appeared first on The Student Loan Sherpa.

Steve is about to be the lucky recipient of a large sum of money from his family. He intends to use this money to pay down his student loans. He would like to know if there are any tax consequences of the gift.

Steve writes:

Unfortunately, this kind of gift can trigger a gift tax bill. The good news is that there are ways of avoiding this particular taxation.

Student Loan Payments and the Gift Tax

Under federal tax law, a gift is when you give money (or any property) to others without the expectation that you will receive something of at least equal value in return. You might be making a gift even if you make an interest-free or reduced-interest loan.

When you make a gift, you trigger the “gift tax.” There are exceptions to that trigger such as gifts to a spouse, medical payments, and tuition payments. Unfortunately, student loan payments do not fall within those exceptions. Additionally, the IRS excludes gifts that you give annually if they are under a certain value. In 2024, that value is $18,001. In other words, if you give $18,000 to your family member for student loan payments, you do not have to pay the gift tax.

Like an inheritance, the person making the gift is usually the party responsible for paying the gift tax.

It is also worth pointing out that whether a gift goes directly or indirectly to someone, the tax is still incurred. This means that whether Steve’s family gives him the money directly or just pays off his student loans, they still might have to pay the gift tax.

For more details on gift tax basics, be sure to check out the IRS Frequently Asked Questions on Gift Taxes. Borrowers can find detailed instructions on how to file for the gift tax in IRS Publication 559.

The good news is there are a few ways in which Steve and his family can potentially avoid having to pay any gift tax.

Avoiding Gift Taxes on Student Loan Payments

One of the most common ways to avoid gift taxes is to spread the money out over several years. Steve’s family could give him $18,000 in 2024 and then another $18,000 in 2025 without triggering any gift tax.

The gift tax also treats spouses as individuals. That means Steve’s mom and dad could each contribute $18,000 in 2024 without having to pay any taxes. If Steve received $18,000 from his mom, dad, grandpa, and grandma, he would get a total of $72,000 without any family member having to pay a gift tax.

Student Loan Exception to the Gift Tax

There is one scenario in which a student loan payment from the family may not be subject to the gift tax.

According to the Wall Street Journal payments made by a co-signer towards a student loan are not subject to the gift tax. This is because payments by a co-signer are not gifts. It is merely repayment of a debt owed. For example, if Steve’s mom co-signed his student loans, she is legally responsible for the debt just like Steve. As such, if she paid off a student loan that she was the cosigner on, she wouldn’t have to pay a gift tax on the payment, even if it was more than $18,000.

Paying More than $18,000 on Student Loans

Suppose the full $30,000 from Steve’s email comes from a wealthy uncle, Fred. Fred didn’t co-sign the loan and he is unmarried. Accordingly, he can exclude only $18,000 from the gift tax. The remaining $12,000 is a taxable gift. Even in this circumstance, though, Fred can avoid the gift tax. Fair warning, this discussion gets a little technical.

The IRS offers a lifetime credit, commonly referred to as the unified credit. The unified credit allows Fred to avoid estate taxes when he dies, up to a certain value. As of 2024, the allowable credit was 13.61 million dollars.

The IRS allows Fred to use that credit while he is still living. To use this credit towards the taxable $12,000 (the $30,000 gift minus the $18,000 annual exclusion), Fred needs to file a special return and determine the tax he owes on that amount. For the sake of ease, let’s assume Fred has calculated how much gift tax he owes on the $12,000 and has determined that he owes $1,000. Instead of paying the $1,000, Fred can use $1,000 of his unified credit, thereby avoiding paying for the gift tax. Note: When he dies, his unified credit will be reduced by $1,000.

More on the unified credit can be found on TurboTax and these IRS instructions.

In other words, student loans can be paid off by family members (or non-relatives) without paying any gift tax… as long as you file the proper paperwork.

Bottom Line

Large contributions towards student loan debt are subject to the federal gift tax.

However, there are a number of ways in which borrowers and their families can avoid this tax. Whether you give the money or receive it, make sure to get familiar with these concepts. Once you have your mind wrapped around the basics, be sure to discuss your different options with an accountant to ensure you don’t violate any IRS rules.

Finally, keep in mind that this article just focuses on federal tax issues. Your state may have its own gift taxes that could be triggered by a student loan gift. As with any technical tax question, it is always best to discuss your options with a local tax expert.

The post Student Loan Help From Family Could Mean Extra Taxes appeared first on The Student Loan Sherpa.

Because a huge tax bill at forgiveness is only a possibility, I’ve devised a plan that will help me prepare for this possibility and maximize my options if it doesn’t become a reality.

Why Plan for a Huge Student Loan Tax Bill?

The Public Service Loan Forgiveness borrowers are the lucky ones. Not only do they get their student loans forgiven after just ten years, but the forgiveness is tax-free.

IDR borrowers are not as lucky. As the rules stand right now, many will have to pay taxes on the debt forgiven under IBR, ICR, PAYE, or SAVE. This is because the IRS’s general rule is to treat forgiven debt as income in the year it is forgiven. This rule has given rise to the term student loan tax bomb.

The recent stimulus package had a small student loan provision that could make a massive difference for some IDR borrowers. Loans that are forgiven between now and 2026 will not be taxed. Unfortunately, I won’t be reaching forgiveness that soon, so as the law stands, I still have to plan for a tax bill.

I’m optimistic this tax bill may not ever happen, but I don’t trust Congress enough to assume that I won’t have to worry about it.

My Tax-Bomb Plan is a Roth IRA

Right now, I’m saving money for an uncertain future.

I may need money for a large tax bill. Ideally, that bill never comes. Hopefully, I can set that money aside now and save it for retirement. In this scenario, a Roth IRA makes the most sense.

I use a Roth IRA for three reasons:

1. It is an excellent retirement account.
2. I can withdraw my contributions at any time without taxes or penalties, so if the tax bill comes, I have funds available.
3. If I have some other immediate emergency, I can dip into this savings.

The unique and flexible rules of a Roth IRA make it the ideal type of account for this particular situation.

Roth IRA Flexibility vs. a Bank Savings Account

The top two options for my tax bomb plan were a standard savings account and the Roth IRA.

I was able to quickly eliminate options like a 401(k) or a Traditional IRA. Of the many different retirement accounts, the Roth IRA stood out as the best choice. Most other retirement plans impose a penalty for withdrawals before reaching retirement age. Because I may need the money in about ten years, these plans will not work.

Thus, the decision came down to Roth vs. a savings account.

The significant benefit of a savings account is that it is easy. Every bank offers one, and I can take the money out whenever I like. However, I see two major downsides. First, with that ease comes temptation. It would be easy to pull some money out of that account to make a purchase that isn’t necessary. Additionally, there are no tax benefits, and the interest rates on a savings account are terrible these days.

Having a Roth IRA means major tax advantages. The money inside a Roth account grows tax-free. If it ends up being a retirement account, I can use those funds without facing any tax considerations.

The Roth downside is that only contributions can be withdrawn penalty-free. In other words, if I put $10,000 into a Roth IRA and the balance grows to $10,800, I only have my original $10,000 contribution available for my student loan tax bill. The remaining $800 will have to sit in the Roth account until I hit retirement age… or I will have to pay a penalty on the $800 that got pulled out early.

However, the biggest advantage of the Roth IRA is that I can invest the money to grow my savings. I tend to invest conservatively because I may need the money in about ten years. This route is riskier than a standard savings account, but it has a higher upside. If we ever get more clarity on student loan taxes, I can also change my investment strategy to a longer outlook based on my retirement.

A Final Advantage: Funds in an Emergency

I’m a huge supporter of having an emergency fund. This especially holds true for student loan borrowers. If you depend upon high-interest credit cards to weather a financial hardship, it will be costly.

Many argue that a Roth IRA is an excellent supplemental emergency fund. Ideally, that money gets used in retirement. However, if you face desperate circumstances, the Roth account is a huge asset.

I hope to use my Roth IRA for my retirement. However, I’m ready to use my Roth IRA to pay a large student loan tax bill. If necessary, I have my Roth IRA for a major financial emergency.

I suspect many federal borrowers working towards IDR forgiveness will find a Roth IRA to be an excellent resource.

The post My Plan for the Student Loan Tax Bomb appeared first on The Student Loan Sherpa.

Refinancing usually means a new lender, new interest rate, and new monthly payment.

Fortunately for borrowers, in most cases, refinancing will not impact the student loan interest deduction. However, a small group of borrowers will receive a slightly smaller deduction or lose the student loan interest deduction completely. These borrowers make up a small minority.

Student Loan Refinancing and the Interest Deduction Basics

The IRS has detailed rules regarding the student loan interest deduction, but for the most part, if a student loan was borrowed to pay for most college costs, borrowers can get the deduction.

A Note about the Student Loan Interest Deduction: Compared to most other tax breaks, the student loan interest deduction is pretty lousy.

Only the portion of a student loan payment that goes towards interest is deductible at tax time. The IRS caps the deduction for borrowers above certain income levels.

Suppose a borrower makes $500 per month in student loan payments and pays $100 per month in interest. In this case, the majority of the payment does not qualify for a tax break. Only the portion of the payment applied to interest qualifies for a deduction. Here, the borrower would potentially be able to deduct $1,200 for a year’s worth of payments ($100 times 12 months).

This borrower wouldn’t save $1,200 on their taxes. Instead, they would be taxed as though they earned $1,200 less. In short, thousands of dollars worth of payments during the year might be worth a few hundred dollars at tax time.

Student loan refinancing doesn’t change the rules, and in most cases, it doesn’t change a borrower’s eligibility for the discount. Like the original lender that issued the loan, a student loan refinance company will send out a 1098-E for borrowers that documents the interest spending for a given tax year.

The Times When a Student Loan Refinance Changes the Tax Deduction

There are two primary circumstances where refinancing a student loan can potentially impact the tax break.

Lower Interest Payments – By refinancing at a lower interest rate, a borrower spends less on interest and may end up with a smaller deduction. Whether or not the deduction is changed depends upon the borrower’s income level and amount of debt. However, borrowers shouldn’t change their refinance plans because of this concern. Choosing to spend extra money on interest to save a little bit at tax time wouldn’t make sense.

Personal Loan Refinance – A traditional student loan refinance pays off old student loans and replaces the debt with a new student loan. However, a lender might pay off the existing student loans and replace them with a personal loan. As a personal loan, the debt would not be eligible for the student loan interest deduction. As long as you avoid personal loans and focus on student loan refinancing, you can avoid this issue. Additionally, it is worth noting that student loan refinance rates are typically much lower than personal loan interest rates.

Lenders Eligible for the Interest Deduction

As long as the lender is advertising student loan refinancing, the loan will almost certainly be eligible for the tax break. Lenders have a huge incentive to have the debt be considered a student loan instead of a personal loan due to bankruptcy rules. Borrowers concerned that their loan won’t qualify should look at the loan contract to verify that it is a student loan and not a personal loan.

Many lenders, including companies like Lending Tree and Lending Club, offer personal loans. These loans are not eligible for the student loan interest deduction.

Some companies, such as SoFi and Earnest, offer both personal loans and student loan refinancing. However, these lenders clearly identify which loans are personal loans and which loans are student loan refinancing.

The student loan refinance lenders from our rankings are all eligible for that tax deduction.

Finally, borrowers should know that interest rates on a student loan refinance are almost always significantly lower than for a personal loan. Rarely will it ever make sense to seek out a personal loan instead of a traditional student loan refinance.

Does Federal Direct Consolidation Change the Interest Deduction?

In most matters dealing with student debt strategy, federal loans, and private loans behave differently.

However, in this instance, federal direct consolidation works similarly to student loan refinancing.

Borrowers who use federal direct consolidation for their fed loans will still receive a 1098-E, and they will still be able to claim the student loan interest deduction each year.

Other Hidden Costs of Refinancing

Borrowers investigating the student loan interest deduction implications on refinancing should also examine the other hidden costs of refinancing.

Even though the interest deduction is mostly unchanged, there are other significant consequences, especially for those considering refinancing a federal government student loan.

The post Refinancing and the Student Loan Interest Tax Deduction appeared first on The Student Loan Sherpa.