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Is Financial Aid Taxable Income? How About Student Loans?

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Financial aid that you receive for college is usually not taxable, but there are exceptions. If you’re a non-degree student, for example, or if you spend financial aid on non-qualified expenses, you might have to pay taxes on it.

Fortunately, student loans are not taxable. Let’s take a closer look at the tax implications for different types of financial aid and loans and other key issues by answering the following questions:

Is financial aid taxable?

How do I report my financial aid to the IRS?

How about student loans — are they taxable income?

What is the student loan interest deduction?

When can student debt be taxed as income?

Plus: Final thoughts on financial aid counts and taxable income

Is financial aid taxable?

Does financial aid count as taxable income? Generally the answer is no, but this can change depending on the type of aid and other circumstances. We’ll look at student loans later in this report, but first let’s consider the following:

Grants and scholarships

Graduate fellowships

Work-study

Part-time jobs

Grants and scholarships

Whether you claim scholarships and grants as income on your taxes depends on how you use the money, explained Josh Zimmelman, owner of Westwood Tax & Consulting LLC in New York.

“Financial aid and grants are generally not considered taxable income, provided the money is spent for tuition, fees, books and other supplies for classes,” he said. “Grants and scholarship money used for other purposes, like room and board, must be reported as taxable income.”

In other words, grants and scholarships awards that are used on qualified education expenses, as defined by the IRS, are not taxable. However, if you use that money on non-qualified expenses, such as room and board, travel or other personal costs, you’re expected to report that money on your taxes.

What’s more, your financial aid awards could be taxable if you’re not pursuing a degree in an eligible educational program. If you spend scholarship or grant money on a non-degreed program, you’ll likely have to pay taxes on it.

Finally, a scholarship or grant award could be taxable if it represents payment for teaching, research or other services.

Graduate fellowships

As a graduate student, you might receive a fellowship to cover your school costs. As long as you’re using that fellowship on qualified education expenses in a degree program, it’s unlikely to be counted as taxable income.

However, if you’re receiving the fellowship in exchange for work, it could be treated as taxable income. Basically, you need to find out whether your fellowship is being treated as a scholarship award or as earned income in exchange for teaching, research or other services.

Your financial aid office should be able to help you decipher the tax rules around your graduate fellowship.

Work-study

Work-study awards are often available to students with financial need. The work-study program provides part-time jobs to undergraduate and graduate students, often on-campus.

Since students make an income from work-study jobs, they have to report it to the IRS. While work-study is a type of financial aid, it is still money earned. That means it has to be reported to the IRS and is typically taxable.

Part-time jobs

Many college and graduate students work part-time jobs to cover the cost of school. Unfortunately, there are no special tax breaks for students who work while they study. You’ll still need to pay taxes on your earnings.

How do I report my financial aid to the IRS?

If you use your financial aid, specifically your grants, scholarships and federal student loans, on qualified education expenses, you don’t need to report it as income to the IRS. The IRS doesn’t get a 1099 or W-2 for your financial aid money.

However, you should report any money you make from a work-study position. And if you have a taxable portion of financial aid (i.e., money that you used on non-qualified education expenses), you typically report that as part of your adjusted gross income with Form 1040.

It can be tough to figure out if any part of your financial aid needs to be reported, so it’s a good idea to ask your financial aid office. A financial aid officer can sort through your financial aid awards and let you know if any of it fell outside the rules for education expenses and needs to be reported to the IRS. A qualified accountant can also help you sort through these murky waters.

Are student loans taxable income?

The short answer is no.

“Student loans are not considered taxable income because it is expected that you’ll pay that money back at some point,” said Zimmelman.

When you borrow money to pay for school, you don’t need to report your loans as income on your tax return. It might feel like you should because you’re receiving money, but those funds aren’t truly yours. Loans are borrowed money that you have to pay back with interest.

But rather than counting as income on your taxes, Zimmelman pointed out, student loans can actually provide some tax benefits.

What is the student loan interest deduction?

Once you start repaying your student loans, you could receive a tax break because the interest you pay is tax-deductible. The student loan interest deduction allows you to deduct from your taxable income up to $2,500 a year in student loan interest that you paid, potentially lowering your total tax bill.

There are some restrictions, though. You can’t take the deduction if your tax filing status is married filing separately, if someone else claims you as a dependent on their tax return or if your modified adjusted gross income is $85,000 or more (or $170,000 or more if you file taxes jointly with a spouse).

While in school, you can also claim tax credits for your education using the American Opportunity Tax Credit or the Lifetime Learning Credit. The advantage of tax credits is that they directly lower the amount of taxable income — and thereby the tax you owe.

If you qualify, the American Opportunity Tax Credit can result in a tax credit of up to $2,500 per year for your first four years of college. The Lifetime Learning Credit allows you to claim up to $2,000 per tax return.

When can student debt be taxed as income?

While student loans are not considered income when the money is disbursed to you, you may not be completely in the clear.

When your loans are forgiven, you don’t have to pay the debt back. In some cases, the forgiven balance could then be considered money you received as a benefit, making it taxable income. This typically includes any forgiveness you may receive as the result of an income-driven repayment plan.

Under these plans, your monthly loan payments are tied to your income and you repay your debt for 20 or 25 years, depending on the plan you chose. Once that repayment period is complete, any remaining student loan balance is forgiven. At that point, the forgiven amount is considered income, meaning a higher federal income tax bill for you.

Note that taxes on loan forgiveness have been waived until 2025 as part of the March 2021 American Rescue Plan. Thanks to this legislation, you don’t have to worry about paying taxes on your forgiven student loan balance.

You also never have to worry about paying taxes on forgiveness you receive from the Public Service Loan Forgiveness or Teacher Loan Forgiveness programs. If you qualify for these programs and your remaining loan balance is forgiven, you won’t have to pay taxes on the forgiven amount.

Before pursuing a plan that involves student loan forgiveness, consider consulting with a tax professional to determine the impact.

Final thoughts on financial aid and taxable income

For many people, paying for college without taking on federal aid or student loans is extremely difficult. That means it’s important to understand how your financial aid and student loans impact the rest of your life, including your taxes.

In most cases, your financial aid and student loan debt won’t be taxed as income, and you may even benefit from the student loan interest deduction or another tax credit. But keep in mind the situations when you could face a tax bill for your aid or loans. That way, you can prepare for a potential tax bill long before it’s due.

 

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