Do Student Loans count as Income: learn more before filing your Taxes

Learn more about taxable income. Understand what comes under taxable and non-taxable income.Figure out the impact of grants and scholarships as well as loan forgiveness on your taxes.

Updated by Vidish S on 7th February 2020

We all know that filing your taxes is not something one is usually taught at school or even college for that matter(unless you’re studying in Financial domains). Which means when the tax filing season finally approaches, it will be important to understand how student loans, scholarships, and grants factor into your taxes, especially if you’re new to the process, like many college students.

Correct and timely reporting of your income will help you avoid stress, paperwork, and other headaches as well.

Filing taxes as a student might be very confusing indeed, especially if you have multiple sources for paying your student loans. Keep reading to get a closer look at how the IRS, lenders, and landlords see your student loans.

Table of Contents

What Financial Resources are considered as Taxable?

According to the IRS, almost everything you earn can come under taxable income: wages, salaries, commissions, interest and dividends, tips, rental income, as well as money earned from side businesses.

However, that does not mean you will have to pay tax on all of it, that depends on your taxable income, calculated after factoring in the adjustments and deductions from your gross income.

Utilizing various forms of financial aid to pay for your education can lead to some of them being taxable. Some taxable aids are:

Tuition assistance provided by your employer. Some employers offer tuition fee repayment assistance to attract talent. This helps employees offset the financial costs related to their education.

Student-athlete stipends. Division I and II athlete students receive scholarships that cover their tuition fees as well as room, board as well as course-related books. Athletic scholarships are considered tax free if they pass certain qualifications. although expenses covering room and board, along with any stipend provided by the school is taxable income.

Learn more about the Best Student Loans that can help you save money.

What Financial Resources are NOT considered Taxable?

If you use any of these sources to pay for your education, you're in the clear:

Student loans, scholarships, and grants. Federal and private student loans are not considered as taxable as you still need to repay the money. But do note that in case part of your debt is settled or forgiven at any point in the future, you will have to pay taxes on those amounts.

Academic grants and scholarships aren't usually considered as taxable income, barring a few exceptions: If your scholarship covers for amounts beyond your tuition and college fees, then income tax will be levied on the difference beyond the fees. And, if scholarship money is used to pay for the room, travel, and optional equipment, you'll have to pay taxes on the amount used for these expenses.

How are taxes affected by Grants and Scholarships?

The IRS has some rules specific to scholarships and grants and what is and isn’t considered taxable income. You are not required to pay taxes on your grant or scholarship if you:

  • Are currently enrolled.

  • Use the grant for payment of educational expenses at an eligible institution.

Educational expenses” include tuition and other associated fees, along with the required materials such as books. Do keep in mind that it doesn’t include supplementary expenses such as room and board or transportation.

For example: let’s say you received a scholarship in the amount of $8,000 for the school year. You put $4,000 towards the year’s tuition, $400 towards books, and you used the rest ($3,600) to pay for room and board. You would only need to list the $3,600 you spent on room and board (non-educational expenses in the eyes of the IRS) as income. Because the other $4,400 was spent on tuition and qualified school expenses, it doesn’t count as taxable income.

Does Loan Forgiveness affect my Taxes?

Having your student loans forgiven sounds great and it is great in many regards. But something that a lot of people applying for student loan forgiveness programs fail to take into account is the implications of the tax being levied on the amount being forgiven on their student loans.

The IRS considers forgiven student loans taxable income per 26 USC 61 (a) (12) (Cornell Law School). The canceled debt amount has to be reported on an IRS Form 1099-C ( instructions) if it’s more than $600.

There are, however, exceptions to this rule including the following:

  • Public Service Loan Forgiveness, Teacher Loan Forgiveness, and other types of occupation-dependent forgiveness.

  • Death and disability discharges.

  • Closed school discharges.

  • False Certification Discharge.

If you’re considering student loan forgiveness and you’re not eligible for tax-free loan forgiveness under one of these programs, it’s important to consider how much you will owe in taxes due to student loan discharge. The amount discharged will usually be taxed for the year during which you received the forgiveness.

Tax Credits for education

Another thing to be aware of going into tax season is tax credits that apply to education. A tax credit is a tax incentive that allows certain taxpayers to subtract the amount of the credit they have accrued from the total they owe the state. If you’re a college student, you may be eligible for one of these tax credits that can reduce the amount you’re required to pay significantly.

American Opportunity Tax Credit

This tax credit applies to undergraduates who have not completed the first four years of postsecondary education as of the beginning of the year.

To qualify for this, you need to be enrolled in a program at a recognized institution and working towards a degree or certificate.

An eligible student can get a maximum credit of $2,500 through the AOTC. 

This may bring the amount you owe in taxes to zero or below zero, in which case you could have up to 40% of the remaining credit amount (up to $1,000) refunded to you.

Lifetime Learning Credit

Along with the features of American Opportunity Credit, this credit has some additional features. This credit is similar to the American Opportunity Credit, but it can be applied to postsecondary education, as well as any courses you might take to improve your job skills.

With the Lifetime Learning Credit, you can claim a credit up to a maximum of $2,000. Unlike the American Opportunity Credit, this credit is nonrefundable, which means you won’t get the money refunded to you. However, it can significantly reduce the amount you owe on your taxes.

Tax forms that you may need

If you’re away at school but your permanent address has stayed the same, tax forms might be sent to your parents’ address. It’s a good idea to watch out for certain documents that you’ll need to file your taxes and ask your parents to do the same if your address is still listed as their house.

Depending on whether you work a job and other factors, you need to note one or more documents of the following.

  • W-2: W-2 is the standard tax information form issued by employers. If you had a job and didn’t receive a W-2, then inform your employer to make sure they sent it to the right address.

  • 1098-T: The form 1098-T will be sent by the college where you study. If you paid tuition, you should receive this form from your college. Form 1098-T will include information you’ll need to fill out your tax return, including tuition paid, related expenses, scholarships and grants you received, and adjustments from the previous year.

  • 1098-E: The form 1098-E helps you verify the information on your tax refund if you paid interest on your student loans. You should receive this form if you paid $600 or more in interest over the year. (If you’re a current student, you may not yet be paying off the interest on your student loan, so you wouldn’t need this form.)

  • 8863: Form 8863 is needed if you qualify for education credits like the American Opportunity Credit or Lifetime Learning Credit.

When student debt could be taxed as income?

Even though student loans do not come under taxable income when the money is disbursed to you, you may not be completely in the clear. 

When your loans are forgiven, the remaining debt is paid off by the government on your behalf. In such cases, the forgiven balance is then considered as money that you received as a benefit, which makes it taxable income. 

This also includes any forgiveness you may receive as the result of being a part of or applying to an income-driven repayment plan.

Under these income-driven repayment plans, your monthly loan repayments are tied to your income, specifically your discretized income and you repay your debt for 20 or 25 years, in accordance with a plan of your choosing. After the completion of the said repayment period, any outstanding student loan balance is forgiven. At which point, the forgiven amount is considered as your income, which eventually means a higher federal income tax bill in your name when it is time to pay your taxes.

There are exceptions to this rule, namely the Public Service Loan Forgiveness and Teacher Loan Forgiveness. If you have qualified for these programs and have your remaining loan balance forgiven, you still won’t have to pay taxes on the forgiven amount.

Before you decide to pursue a plan regarding student loan forgiveness, consider consulting with a tax professional to determine how your taxes will be affected.

Final Thoughts

Though student loans by themselves do not largely count as taxable income that affects your taxes, there are some conditions and caveats associated with them, the same is true for grants and scholarships as well. Do research ahead of time, before the tax filing season to figure out the proper taxable streams that apply to you and consider contacting a tax professional for more help on the same.