Editor’s Note: This article was updated on December 19, 2019, to include updated information for the upcoming 2020 tax season.
Most student loan borrowers realize that there is a deduction for student loan interest. However, there are many other student loan issues to consider at tax time.
Not only is tax season a great time to do a student loan checkup, but a smart tax strategy can result in lower student loan payments for the next year.
This article will cover everything from the student loan interest deduction to advanced strategies for lower payments, a lower tax bill, and a bigger retirement account.
The Student Loan Interest Deduction
Borrowers may recall that 2018 was the first tax year under the rules of the “Tax Cuts and Jobs Act.” While there were many changes to the tax laws, the student loan interest deduction stayed mostly the same.
Borrowers can 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 isn’t 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.
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 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 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 comprehensive tool for determining if you qualify.
Timing Income Certifications
Borrowers on an income-driven repayment plan have to 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 an income-driven repayment plan may want to consider the timing of their application. Those who made less in 2018 than what they made in 2019 will be better off applying for the income-driven repayment first. This way, the borrower’s ability to pay will be based upon their 2018 return rather than the yet-to-be-filed 2019 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 beneficial to review recent payments. Check to see how much is applied to interest and how much is going towards the 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. Also verify that it is coming out of the right bank account.
Look for Late Fees – Lenders are experts at adding 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 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 SoFi or CommonBond.
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 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 applied. IRA contributions from January through April 15 can be applied towards the 2019 tax year or the 2020 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 useful for borrowers working towards federal student loan forgiveness programs.
By making this move, borrowers can:
- Lower their tax bill,
- Save extra money for retirement,
- Lower their student loan bill for the next year, and
- 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 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 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 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.
- 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 for many borrowers, it doesn’t make sense 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 from filing jointly and lowering their income via retirement contributions rather than filing separately.
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.