Do Student Loans Count As Income?

As you navigate your academic journey, you might wonder about the financial implications of student loans. If you took out a loan or multiple loans to fund your education, as is the case for more than half of all college graduates, you might be asking, “Are student loans counted as income?”

In general, the Internal Revenue Service (IRS) doesn’t count student loans as income, but there are some exceptions to be aware of. Let’s walk through some key considerations so you don’t have to worry about a surprise tax bill.

Do Student Loans Count As Income For Taxes?

Because student loans generally don’t count as income for tax purposes, you don’t have to pay income tax on them. That is, student loans aren’t taxable income in the same way that the money you earn from a traditional job would be.

Income is money you earn and aren’t expected to repay. Since you’ll be repaying your student loan to your lender, it isn’t considered income – regardless of whether it’s a private or federal student loan. That’s good news, because the higher your income, the higher your taxes will often be when you file your tax return.

Student Loan Forgiveness

Although, broadly speaking, student loans don’t count as income for tax purposes, there’s one important exception here: loan forgiveness.

When you have a portion of your student loan debt canceled and it’s not tied to services you render in connection with an employment agreement, the IRS may view the portion of the loan that’s forgiven as taxable income.

This might seem somewhat contradictory to the idea or definition of income but when a debt is canceled, you’re essentially receiving financial assistance, which the IRS categorizes as income.

Of course, every situation isn’t cut and dry. There are three types of loan forgiveness options:

• Income-driven repayment plans
• The Public Service Loan Forgiveness Program
• The Teacher Loan Forgiveness Program

Non-Taxable Student Loan Forgiveness

There are two situations in which student loan forgiveness is non-taxable: the Public Service Loan Forgiveness Program and the Teacher Loan Forgiveness Program.

• The Public Service Loan Forgiveness Program: This forgives the remaining balance on Direct Loans after 120 qualifying monthly payments while the borrower is employed full time in public service. Eligibility requires direct employment with a qualifying employer – which could be a federal, state, tribal or local government agency, or a nonprofit organization.
• The Teacher Loan Forgiveness Program: This offers loan forgiveness for teachers with federal student loans (Direct Loans). Teachers must teach full time for 5 complete and consecutive academic years in a low-income elementary or secondary school, or an educational service agency.

If you had your loan forgiven through either of these programs, you typically don’t have to pay taxes, and the forgiven amount isn’t considered income.

You’re essentially providing a “service” in exchange for the forgiveness, so it’s not financial assistance.

Taxable Student Loan Forgiveness

Matters get tricky with income-driven repayment plans. The federal government offers 20- to 25-year income-driven repayment plans, which base your monthly payment on your income and family size.

For income-driven repayment plans, you must pay taxes on the forgiven amount in the year of cancellation. Unlike annual taxation, this occurs when the repayment term concludes.

For example, if you still owe $10,000 at the end of your repayment period, you will pay taxes on the $10,000.

However, the American Rescue Plan Act of 2021 made student loan forgiveness tax-free at the federal level until the end of 2025. This includes income-driven repayment plans. State taxes may still apply, however.

Are Student Loans Counted As Income By States?

The federal stance on student loan taxation is relatively clear-cut. However, state laws differ, so you’ll want to pay attention to the tax laws where you live.

You may not need to pay federal taxes on your student loan debt, even if you’re in a forgiveness plan. However, you may be on the hook for state tax.

Several states levy a tax on the amount you’re forgiven in federal student loans. These states are Arkansas, Indiana, Mississippi, North Carolina and Wisconsin.

Some programs, including the Public Service Loan Forgiveness Program, may still be excluded from taxation in those states. It’s best to consult a tax professional in your state so you’re fully aware of the laws where you live.

Are There Tax Benefits For Paying Your Student Loans?

In addition to not viewing student loans as taxable income, the IRS offers another carrot to borrowers: Paying your student loans can qualify you for tax deductions, which can save you money on your tax bill.

When you repay your student loans each month, you qualify for a student loan interest deduction. The amount you qualify for will vary but can be as high as $2,500 per year. For you to be eligible, no one can claim you as a dependent on their tax forms. You’ll also need a 1098-E tax form, which your student loan servicer should send you.

If you’re in the early stages of loan repayment or a substantial portion of your payments consists of interest, this deduction can make a big difference.

Some people may also wonder if paying off your student loans early carries any tax benefits. In general, the answer is no – you’ll receive a tax deduction for any interest paid, but there’s no additional boost for paying your student loans off all at once.

Do Scholarships And Grants Count As Income?

While student loans don’t count as income technically speaking, scholarships and grants do. Even though this isn’t income you earned from a job, the IRS still treats it as income.

Here’s a breakdown of when scholarships and grants count as income:

• Scholarships and grants not used for tuition: Typically, scholarship money and grant money is only taxable if you used it on something besides tuition. For example, if you use $1,000 of a scholarship to pay for books, this money would be considered taxable income.
• Employer-provided tuition programs: Employer-provided tuition programs are taxable, but that’s only the case for amounts over $5,250. You’ll receive tax forms from scholarship and tuition assistance providers if you’re expected to pay taxes on these distributions.
• Federal work-study: Federal work-study programs and student-athlete stipends are also considered taxable in most cases. Interestingly, resident assistance stipends for room and board are often not considered taxable income. The same is true for college savings plans.

Are There Any Tax Breaks For Student Loans?

Several tax credits and deductions are available to help alleviate the financial strain of getting a higher education. Tax credits directly lower your tax bill, while tax deductions can reduce your taxable income.

• The American opportunity tax credit: This credit allows you to claim up to $2,500 annually for the first 4 years you spend in school (as long as you’re progressing toward a degree or other credential).
• The lifetime learning credit: This credit allows you to claim up to $2,000 annually for college or career tuition, fees, books and supplies. Available for all postsecondary years and job-skill courses, it aids non-degree-seeking students pursuing financial assistance for professional development.
• Student loan interest deduction: This allows you, your spouse or your dependent to deduct up to $2,500 annually based on your interest paid and income level. To claim this deduction, you’ll need to receive a 1098-E form.

The Bottom Line: Student Loans Don’t Count As Income

Understanding student loans and their associated tax obligations can be tricky, but it doesn't have to be stress-inducing. In almost all cases, student loans aren’t considered taxable income, and you can take advantage of tax deductions and credits to ease the financial load of funding your education.

If you still aren’t sure how student loans might affect your taxes, don’t hesitate to reach out to a tax professional for more personalized advice.

While you’re at it, be sure to download the Rocket Money℠ app. By managing your student loan-related finances with confidence, you can get the most out of your education and start building for a successful future.