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Four Ways Student Loans Can Help (or Hurt) Your Tax Liability

student tax debtSeven out of ten college graduates emerge from their undergraduate program with student loan debt, according to an analysis by the Institute for College Access & Success. While borrowing to fund higher education has become the norm for many families and students, student loan debt can present some unique tax implications. Here’s a look how student loans can work for, or against you, when you file your Federal tax return.

The interest you pay could lower your tax liability.  You may be able to reduce the interest you pay for student loans (either for yourself or a dependent) when you file annual taxes, but whether you can take the $2,500 deduction in full depends on your modified adjusted gross income, and how file.  Single filers are eligible to claim up to $2,500 in student loan interest paid in a tax year provided their MAGI is less than $80,000 in that tax year; joint filers can do the same provided their MAGI isn’t more than $160,000. The student loan must also have been taken out for the sole purpose of funding higher education costs to qualify for the deduction; employer-reimbursed student loans or those secured under employer plans aren’t eligible.

If you paid more than $600 student loan interest in the tax year, your lender(s) will send an official Form 1098-E reflecting the total interest paid that year in “Box 1.” If you don’t receive a form from a lender, you may not have paid more than $600 in interest that tax year, on that particular loan but you may still be eligible to claim whatever interest you paid. (Check your monthly loan statements).

If you secured the student loans before 2004, you may be able to deduct a portion of any origination fees or capitalized interest, too. (Box 2 on your 1098-E form will be checked in this case). Divide the total number (of each) by the number of years left on the loan to determine how much may be considered deductible for the tax year.

Claiming expenses for education-related tuition and fees could help you owe less tax.  The Federal government offers students the opportunity to claim several education-related credits like the American Opportunity Credit, the Lifetime Learning Credit, and the ability to deduct some course fees and tuition expenses. Yet, who qualifies for these credits (and much value it ultimately delivers) depends on variables including the student, the loan type, expenses, the education being pursued, and by whom. The IRS offers an interactive calculator to help taxpayers determine what education-related credits and deductions they may be able to claim.

Not paying Federal student loans could lead you to lose your tax refund.  Federal student loans may offer lower interest rates than those typically offered by private student lenders, and allow for income-based repayment plans and even some debt forgiveness options for borrowers who secure jobs in public service, teaching, healthcare, or at charitable organizations. (If you qualify for a reduced repayment, you may still deduct the interest up to $2,500, assuming you meet the criterion noted above).

But Federal student loans aren’t entirely beneficial to the borrower. Though there are some rare cases where filing bankruptcy can reduce or eliminate amounts owed on Federal student loans, the process isn’t simple, and usually requires proof of financial hardship. Further, any tax refund owed by a borrower could be intercepted by the U.S. Department of Education and applied to Federal student loans that have gone unpaid for 270 days.  Though you will receive a official letter of notification before that happens, you cannot stop the process unless you agree to establish a repayment plan, and start making the newly agreed to payments before the deadline stated on the letter.

Forgiven student loans can be considered taxable income. Securing student loan debt forgiveness can eliminate education debt that would otherwise take years to pay off, but it could be taxed like income you were paid, based on the terms of the loan forgiveness. If you qualify for public service loan forgiveness, teacher loan forgiveness, or law school loan repayment assistance forgiven debt is likely not taxable, but student loans discharged because a school closed, or due to death and disability may be treated as taxable income. Student loan forgiveness related to some income-contingent repayment and income-based repayment plans may be considered taxable, too. If that’s the case, you’ll receive a 1099-C (Cancellation of Debt) form, which you will then report it when you file taxes. If you cannot pay the taxes owed as a result, you’ll need to arrange for an installment plan with the IRS until your tax bill is paid in full.

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Stephanie Taylor Christensen was a financial services marketer for more than a decade before becoming her own boss, as a full-time freelance writer and the owner of Om for Mom prenatal yoga in Columbus, Ohio. Her coverage of personal finance, career, and small business news is regularly syndicated in national publications including Real Simple, USAToday.com, ForbesWoman, The Huffington Post, and Yahoo!Finance.