Do Student Loans Count As Income For Tax Purposes?
Jerry Brown5-Minute Read
July 15, 2021
When you file your taxes each year, you pay income tax on your earnings. If you’ve taken out student loans to pay for school, you may wonder, “Do my student loans count as income?” Fortunately, the short answer is no. In most cases, your student loans won’t increase your tax bill, but they can impact your taxes in other ways.
Let’s take a deeper look at how student loans, as well as scholarships, grants and financial aid, can impact your taxes.
Are Student Loans Considered Income?
Since you typically have to repay your student loans (federal and private) in full, plus interest, the IRS considers it debt and not income. However, if some or all of your student loan debt is canceled, the forgiven amount can be considered taxable income.
When you apply for a loan, a lender considers your student loan debt for the purpose of calculating your debt-to-income ratio (DTI). It is calculated by dividing your monthly debt payments by your gross income – your total earnings before deductions and taxes are taken out. If your monthly debt is $1,000 and your gross income is $2,000, your DTI ratio is 50%.
Your DTI ratio is important because lenders use it to determine whether you qualify for and can afford to repay a loan. For example, if you’re applying for a mortgage loan, lenders typically require you to have a DTI ratio that’s 43% or lower. If your ratio is higher, it can decrease your chances of having your loan approved.
Are Student Loans Taxable?
If all of your student loan debt is repaid, you don’t have to worry about paying taxes on your student loans because the IRS only taxes income, not debt. When all or a portion of your student loan is canceled, however, you may have to pay taxes on the forgiven amount.
Student Loan Forgiveness
If you have a federal student loan, you may qualify for student loan forgiveness through an income-driven repayment plan, Public Loan Service Forgiveness Program (PSLF) or Teacher Loan Forgiveness Program (TLFP).
- Income-driven repayment plans: The federal government offers income-based payment plans that range from 20 to 25 years. When the program ends, your remaining loan balance is forgiven.
- Public Service Loan Forgiveness Program: If you work for a government or not-for-profit organization, you may qualify for forgiveness after making 120 “qualifying” payments.
- Teacher Loan Forgiveness Program: After teaching in a low-income school full-time for 5 straight years, you might qualify to receive up to $17,500 of forgiveness on federal direct loans (unsubsidized or subsidized).
Tax-Free Student Loan Forgiveness
If you’re enrolled in the PSLF or TLF programs, you don’t have to pay taxes on the forgiven amount – the IRS doesn’t consider it income.
Taxable Student Loan Forgiveness
Borrowers who are enrolled in 20- to - 25-year income-driven repayment plans normally have to pay taxes on the forgiven amount in the tax year the cancelation occurs. However, Congress passed a bill last year to make canceled student loan debt (federal and private) exempt from federal taxes through the end of 2025.
Since there’s no guarantee Congress will extend federal tax relief on forgiven amounts beyond 2025, it's a good idea to create a plan to cover the tax bill on your canceled student loan debt. That way, you won't be surprised by a huge tax bill if a large amount of your loan balance is forgiven.
State Taxes And Student Loan Forgiveness
While you may not have to pay federal taxes on your canceled student loan debt, you may be responsible for paying state taxes. Since tax laws vary from state to state, you should check with a tax professional in your area to see if your forgiven balance will be considered taxable income.
Scholarships And Grants
Schools, individuals, and organizations often offer scholarships or grants based on merit or financial need. Both are considered gifts – unlike student loans, you don’t have to repay them. If you receive one, the amount you received won't be taxed if you’re actively pursuing a degree and use the funds for:
- Tuition and fees
- Mandatory equipment
However, your scholarship and grant funds will be taxed if you use additional funds for:
- Room and board
- Optional equipment
- Other personal expenses
Also, you may have to pay taxes if you receive a scholarship or grant in exchange for doing research, teaching or performing other services. An exception to this rule is if you perform services to receive a scholarship or grant through the Armed Forces Health Professions Scholarship or National Health Service Corps Scholarship Program.
Employer Tuition Assistance
Some employers offer tuition assistance as an employee benefit. Like student loans, scholarships and grants, these benefits may impact your taxes. The IRS currently allows an employer to contribute up to $5,250 per year toward your education without it impacting your taxes.
However, the amount of benefits you received over that, must be included in your gross income.
Tax Benefits For Paying Off Student Loans
When you repay your student loans, you may qualify for a student loan interest deduction of up to $2,500 per year. To qualify for this deduction, you can’t be claimed as a dependent. Filing it requires that you have a 1098-E tax form. Your student loan servicer normally mails or emails you this form. Alternatively, you can download the form from its website.
Using Student Loans As Income For Other Purposes
When applying for a loan or credit card, in addition to looking at your DTI ratio, a lender will consider your income. In general, the more income you have, the greater your chances are of being approved for a loan. So, if student loans were counted as income, it would be beneficial to borrowers.
Unfortunately, online lenders, banks and credit card issuers view student loans as debt.
That said, if you want to use funds received for your education expenses as income, some lenders may consider scholarships or grants as income. To see if this is the case, contact the lender you’re trying to borrow money from. At this time, this isn’t something offered by Rocket Mortgage®.
The Bottom Line: Student Loans Do Not Count As Income
When you file your taxes, your student loans do not count as income for tax purposes. However, you may be responsible for paying taxes if all or a portion of your student loan balance is forgiven. Scholarships and grants also don’t count as income, as long as they’re used for tuition fees, school supplies and textbooks.
If you’ve started repaying your student loans, don’t forget to claim the student loan interest deduction on your tax return. It can help lower your taxable income.
Is your monthly student loan payment too high? You may qualify for a lower interest rate and monthly payment if you refinance it. To learn more, read our article on how to refinance your student loans.
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Student Loan Forgiveness Programs And How They Work
Student loan forgiveness is the complete or partial cancellation of a student’s federal loan repayment. Learn more about how it works.