5 Things to Know About Student Loan Debt

Outstanding student loan debt is estimated to be $1.7 trillion. Many borrowers struggle to repay their debt. There are various repayment programs to help restructure loan in order to ease the burden. Nonetheless, it may take years for some to pay off their obligation. Fortunately, the federal government has provided some help in the form of certain loan forgiveness and a few helpful tax rules. Here are 5 things to know.

1. Interest on student loan debt may be deductible

If your modified adjusted gross income (MAGI) is below a threshold amount, you can deduct interest on your student loan debt up to $2,500 each year. This is an adjustment to gross income, so you can take the deduction whether you itemize or use the standard deduction.

For 2021 returns, the MAGI limit on deductibility is $170,000 on a joint return, or $85,000 if single, head of household, or qualifying widow/widower. But there’s a phase-out of the deduction for MAGI between $140,000 and $170,000 for joint filers, or between $70,000 and $85,000 if single, head of household, or qualifying widow/widower. For 2022, the MAGI phase-out stays at $70,000 to $85,000 if single, head of household, or qualifying widow/widower, and for joint filers, it increases slightly to MAGI between $145,000 and $175,000.

2. Employer payments toward debt repayment may be tax free

If your employer has an educational assistance plan, payments to you or directly to the lender up to $5,250 are tax free. There are no income caps. The exclusion from gross income for this fringe benefit is set to run through 2025.

3. Student loan forgiveness may be tax free

Generally, the cancellation of debt is taxable income. However, certain student loan cancellation may be tax free. This includes loans by those working in certain sectors in specified areas (e.g., doctors and nurses working in underserved communities) as well as cancellations on account of death or the total and permanent disability of the student.

The American Rescue Plan Act expanded the type of loans eligible for tax-free treatment when canceled after December 31, 2020, and before January 1, 2026; it does not mandate that loans be forgiven. The exclusion does not apply if the discharge is conditioned upon performing services for the organization or private lender. Eligible loans that can be canceled without generating taxable income for the borrower include:

1. Loans for post-secondary educational expenses if the loan was made, insured, or guaranteed by a federal, state, or local governmental entity or an eligible educational institution.
2. Private education loans, which defined in Section 140(a)(7) of the Truth in Lending Act.
3. Loan made by most nonprofit colleges and universities where the loan is made under an agreement with any governmental entity or any private education lender that provided the loan to the educational organization, or under a program of the educational institution that is designed to encourage its students to serve in occupations with unmet needs or in areas with unmet needs and under which the services provided by the students or former students are for or under the direction of a governmental unit or a tax-exempt charitable organization.
4. Any loan made by an educational organization qualifying as a 50% charity or by a tax-exempt organization to refinance a loan to an individual to assist the individual in attending any educational organization if the refinancing loan is under a program of the refinancing organization that is designed as described above.

Note: The IRS has told lenders NOT to issue Form 1099-C to report this loan forgiveness. If a borrower receives a form despite the IRS’s directive, it’s likely the borrower will receive a letter from the IRS; the government thinks the forgiveness is taxable. It will be up to the borrower to explain the situation to the IRS.

 4. There’s a freeze on repayment of certain student loans

When the pandemic began, the federal government put a freeze on the repayment of certain student loans, along with a zero interest rate for the period of the freeze. This relief, which began in March 2020, has been extended several times. It had been set to expire on January 31, 2022, but has been extended once again to May 1, 2022 (an additional 90 days).

The freeze applies only to federal student loans and other loans “on the federal balance sheet.” Loans NOT subject to the freeze include:

• Privately owned Federal Family Education Loans (FFEL)
• Perkins loans through schools
• Private loans from banks and other entities

Note: The period of the freeze is favorably counted for purposes of loan forgiveness for the Public Service Loan Forgiveness program as well as for income-driven repayment (IDR) plans.

 5. Tax information is used to determine student loan borrowing

The 2022-2023 FAFSA form for determining student loan debt is based on the 2020 federal income tax return. The IRS Data Retrieval Tool (DRT) is the fastest way to complete the FAFSA form. But not everyone is eligible to use this tool and the tool doesn’t necessarily provide all the financial information needed for the form.

Conclusion

The burden of student loan repayment has led some parents and students to question the advisability of financing higher education through debt. Unfortunately, for many, this is the only option. Where debt exists, look for programs and tax breaks to alleviate the burden of repayment.