Reduced tax refunds after student loan defaults
Most of us know that we need to watch out for things like our mortgages when preparing our taxes. But who would imagine that student loan debt could help you get a bigger tax refund?
Here is an overview of how you may be able to amortize some interest paid on student loans, as well as other tax tips related to university debt. Big hint: don’t default if you want a fat tax refund.
Interest deduction can increase tax refunds
Despite some rumors to the contrary, many people can reduce their tax bill by taking advantage of a deduction on federal income tax returns for interest paid in 2018 on federal and private student loans.
“It’s a nice benefit,” said Cari Weston, director of tax practice and ethics for the American Institute of CPAs.
But she cautions that this is a tax break that only applies to a limited group of people, often young consumers who don’t make much money. Married couples – both of whom are paying off student loans – also face unexpected limits.
The good news is that it is possible to claim this deduction even if you take the standard deduction.
“This is not an itemized deduction,” said Jackie Perlman, senior tax research analyst at H&R Block’s Tax Institute.
Under the Tax Cuts and Jobs Act 2017, more people will benefit from the standard deduction instead of itemizing it. Even if that’s the case, you might still be able to use the student loan interest deduction if you qualify, Perlman said.
This is over-the-limit tax relief, which would reduce your taxable income by up to $ 2,500.
But then again, this is a tax break you can’t always bank on.
Weston said customers could hear about the deduction but not realize all the obstacles.
“People are getting very confused,” Weston said.
As a CPA, she had to break the bad news and tell clients things like, “But in your case, you’re making too much money and you’re not going to get it.”
If you are single, for example, the dollar amount of the student loan deduction starts to be significantly reduced once your modified adjusted gross income exceeds $ 65,000. If you are single, you cannot claim it at all if your modified adjusted gross income is $ 80,000 or more.
For 2018, the phase-out limit for married couples is between $ 135,000 and $ 165,000 if you are filing a joint return. You cannot claim the deduction after you reach $ 165,000 or more if you are filing a joint return.
You are not eligible for this deduction if you are married and are filing separately. Some married student loan borrowers file separately so they can qualify for lower monthly payments under income-based repayment plans. As a result, however, they could lose the deduction for interest payments on student loans.
You cannot claim this deduction if you or your spouse, if you are filing jointly, can be claimed as dependents on someone else’s return.
In the case of married couples, the deduction is per declaration and not per person.
If two borrowers marry, their deduction will drop from $ 2,500 each on single returns to a combined deduction of $ 2,500 on joint return, warned Mark Kantrowitz, editor and vice president of research for Savingforcollege.com.
So, if you are newly married, don’t expect both of you to be able to take advantage of this tax break.
“I call it the classic marriage sentence,” Weston said.
Read the rules carefully. See chapter 4 of Publication 970: Higher Education Tax Benefits for more information on the student loan deduction. Go to www.irs.gov.
There is a worksheet for completing the student loan interest deduction, which you would claim on Annex 1 for the 1040, line 33.
Be sure to see line 7 Adjusted gross income to claim the deduction on page 2 of the new 1040 shorter shape.
This can be confusing for some. You do not see the student loan deduction shown on Form 1040 even though you include it on line 7 under adjusted gross income.
Student loan assistance from employers is taxable
Some employers, such as Dearborn-based Carhartt, are now offering employment benefits, including paying a sum of money for student loan debt. Currently, however, payments made under employer loan repayment assistance plans are taxable to the employee.
“It’s not a tax-free benefit from your employer,” Perlman said.
Scott Thompson, CEO of Tuition.io, a California platform for employee student loan contributions, said some employers would “hike” and offer more money to cover additional taxes. But not all employers do, so employees should take the time to understand the benefits stated.
In the future, you might get a better break.
Kantrowitz noted that there is bipartisan legislation in Congress – dubbed the Employer Reimbursement Participation Act – that would exclude up to $ 5,250 of these tax benefits per year.
Student loan cancellation is a mixed bag
The good news is that student loan debt that is discharged after December 31, 2017 due to the death or disability of the student is no longer taxable. This tax break expires after 2025, and the disability must be a total and permanent disability, according to Mark Luscombe, senior analyst for Tax & Accounting at Wolters Kluwer in Riverwoods, Illinois.
The change was part of the Tax Cuts and Jobs Act of 2017, which came into effect in 2018. The new rule is not retroactive. It applies to federal or private education loans.
Kantrowitz said his research and reading of the law is that this new change applies to paying off debt on a Parent PLUS loan when the student dies. Some tax experts, however, say the IRS might need more advice on some specific issues.
But other types of student loan forgiveness may be taxable right now. You will receive a 1099-C if the canceled debt is $ 600 or more.
But it is important to search for exceptions what is taxable and what is not, Kantrowitz said.
The student loan forgiveness, for example, which is associated with working in certain occupations for a specified period of time, is tax-free. This includes the teacher loan forgiveness and the public service loan forgiveness.
Many times borrowers have to work in some underserved areas to qualify for such a pardon, Weston noted.
It is important to understand all of the specific rules in order to be eligible for a loan forgiveness and to avoid being taxed on benefits.
“Sometimes people are blinded by this,” Perlman said.
To exclude canceled student loan debt from your income, your loan must have been made by an eligible lender to attend a qualifying financial institution.
So, for example, such exclusions from this tax break would not apply to any canceled credit card debt, Perlman said.
Sometimes students can also be inundated with credit card debt, especially if they pay their tuition fees with a credit card and then let that interest grow and grow.
Student loan default reduces repayments
Filers are often shocked when they expect a tax refund of $ 5,000 or more and then find out that they are not getting all of that money. Some or all can be used to pay off a delinquent federal student loan.
If you are missing money in your tax refund, it may have been collected through the Cash compensation program to collect overdue debts owed to federal agencies and state governments.
“Most people will be given sufficient notice before a refund is entered,” said Weston of the American Institute of CPA.
“Just because you don’t pay your loan for a month or two is not going to send them into that kind of aggressive action,” she said.
A student loan default occurs when you fail to make the required payment on your student loan for 270 days – or nine months – or more. The fault is more serious than the delinquency.
Some students, however, lose track of the loans when the debt is sold to another lender and unknowingly fail to make payments. After failing to make these payments, some say they are shocked to see their tax refund seized.
Defaulting, of course, can also hurt your credit score and increase the cost of taking out a mortgage or car loan.