tax strategy and tips for student loan borrowers

Tax Strategy, Tips and Deductions in 2019 for Student Loan Borrowers

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At this time of the year, student loan borrowers should be gearing up to file their 2018 taxes and thinking about strategies to minimize their 2019 taxes.

Even though we are already in 2019, there are still steps borrowers can take to lower their 2018 tax bill and possibly lower their student loan payments in 2019.

This article will cover everything from the student loan interest deduction to advanced strategies for lower payments on federal income-driven repayment plans.

The Student Loan Interest Deduction

Borrowers may recall that 2018 will be the first tax year under the rules of the “Tax Cuts and Jobs Act.”  While there are many changes to the tax laws, the student loan interest deduction is basically the same.

Borrowers are able to claim a deduction of up to $2,500 based upon student loan interest spending.  This deduction applies to both private and federal student loans.  However, money spent paying down the principal balance cannot be counted towards this deduction.  Your lender should mail out a 1098-E tax document with an exact accounting of the money spent on student loan interest.

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 a variety of lenders, be sure to reach out to your lenders to get a 1098-E (though many lenders will still mail one out).  The interest on amounts less than $600 can still be deducted, you just might have to contact your lender for documentation.

For further information, including income limits and phase out, be sure to check out our student loan interest deduction Q and A page.

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

Timing Income Certifications

Borrowers on an income-driven repayment plan have to certify their income on a yearly basis.  Most borrowers certify by supplying the Department of Education with their most recent tax return.

Those who are about to start an income-driven repayment plan may want to consider the timing of their application.  Those who made less in 2017 than what they made in 2018 will be better off applying for the income-driven repayment first.  This way the borrowers ability to pay will be based upon their 2017 return rather than the yet-to-be-filed 2018 return that shows a larger income.

Borrowers who are 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 most 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 really helpful to review recent payments.  Check to see how much is applied to interest and how much is going towards principal.  Borrowers who have the majority of their payments go towards interest will want to 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 amount you want being withdrawn and it is coming out of the right bank account.

Look for Late Fees – Lenders are experts at tacking on fees whenever possible.  Check recent payments to make sure there are not any fees being charged.  If they are, call your lender to dispute the fee and/or find a way to avoid future charges.

Check Interest Rates – Many student loans have variable interest rates.  Because interest rates are currently rising, it is essential to check on 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 SoFi or CommonBond.

Educational Tax Credits

There are a couple 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 good news is that they can save up to $2,500 off your tax bill based upon current education expenses.  The bad news for student loan borrowers is that student loan payments will not count towards either credit.

Anyone who is currently still in school should be sure to understand these educational tax credits.

Take Advantage of Retirement Contributions

Many contributions into retirement accounts such as an IRA or a 401(k) can lower your tax bill.  Because these contributions are above the line deductions, they also lower your AGI.  A lower AGI means your discretionary income is lower.  A lower discretionary income means lower payments for borrowers on an income-driven repayment plan.

That is the technical explanation.  The short version is that the more money you put into your IRA or 401(k), the less you will be required to pay if you are on a federal income driven repayment plan such as IBR, PAYE, REPAY, or ICR.

The neat part about the beginning of the year is that you have some flexibility about what year the contributions are counted towards.  IRA contributions in January through April 15 can be applied towards the 2018 tax year or the 2019 tax year.  Just make sure you don’t make the mistake of trying to count the payment towards both years.

IRAs and 401(k)s are not the only accounts that can be used to lower student loan payments.  Many retirement plans for government employees, such as a 457 plan, will 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 effective for borrowers working towards federal student loan forgiveness programs.

By making this move borrowers are able to:

  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 a number of 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 actually 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 yearly tax routine, you make sure that this critical step does not get skipped over.

The Employer Certification form can be found on the Department of Education’s Website.

File Taxes Jointly or Married Filing Separately

The biggest and most difficult 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 actually be quite difficult, especially when you factor in all the other strategies a 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 Estimator.  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 – Generally speaking, couples who both have federal student loans and are both on an income driven repayment plan will be better off filing jointly.  Many fear that by filing as a couple, their payments will double, but that is not the case.

Borrowers should also keep in mind that while lower payments on their student loans is 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.  Obviously the math changes for those pursuing forgiveness, but for many borrowers it doesn’t make sense to pay extra in taxes just to prolong paying off their 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 from filing jointly and lowering their income via retirement contributions rather than filing separately.

Final Thoughts

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.