Knowing exactly what to do when taxes are due can help relieve some of the stress that comes with filing your tax returns—especially if you’re new to the process, like many college students.
Reporting your income correctly—and on time—will help you avoid unnecessary stress, paperwork and even unpleasant fees, and focus on your studies.
The question is, how do student loans, scholarships and grants factor into your taxes? More specifically, are student loans considered income in the eyes of the IRS?
Good News – The IRS Does Not Consider Student Loans as Income
The IRS doesn’t consider student loans—which must be repaid—income.
Although they’re a part of your total FAFSA “award”, student loans aren’t money you get to keep (unless they’re forgiven, which we’ll address later on). That means they’re not technically “income”, and therefore, not taxable as such.
But the IRS’s rules regarding financial aid aren’t always so cut and dried. For example, things can get more complicated if your loans are forgiven or if you received grants (including Pell Grants) or scholarships.
Additionally, while student loans aren’t considered taxable income by the IRS, there are still some unique tax and credit implications to be aware of when it comes to financial aid loans.
Grants and Scholarships as Income
As with financial aid loans, the IRS has specific rules regarding grants and scholarships and what it considers/doesn’t consider income. The good news here is that you do not have to pay taxes on your grant or scholarship if you:
- Use the grant to pay for education expenses at an eligible institution; and
- Are currently enrolled.
“Educational expenses” include tuition and some associated fees, as well as required materials such as books. In this case, it doesn’t include additional expenses such as room and board or transportation.
You may apply leftover grant money to those expenses, but that leftover amount would be considered income by the IRS.
For example: let’s say you received a scholarship in the amount of $7,000 for the school year. You put $3,000 towards the year’s tuition, $300 towards books, and you used the rest ($3,700) to pay for room and board. You would only need to list the $3,700 you spent on room and board (non-educational expenses in the eyes of the IRS) as income. Because the other $3,300 was spent on tuition and qualified school expenses, it doesn’t count as taxable income.
Student Loan Interest Deductions
When you repay your student loans, a percentage of what you pay—determined by your loan terms—is interest. Once you start repaying those loans, any amount you pay in interest is deductible on your taxes.
This means that, although student loans may not impact your taxes when you get them, it’s still important to keep them in mind as tax implications for the future. Interest paid will need to be listed on your taxes as deductions if you want to get your biggest possible return.
Note that, since the original loan amount was not taxed as income, you cannot list entire payments on your loans as deductions. Only the amounts which go towards interest count as deductible expenses.
Tax Credits for Education
Another thing to be aware of going into tax season is tax credits that apply to education. If you’re a college student, you may be eligible for one of these tax credits that can reduce the amount you’re required to pay significantly.
This tax credit applies to undergraduates who have not completed the first four years of postsecondary education as of the beginning of the year.
To qualify, you need to be enrolled in a program at a recognized institution and working towards a degree or certificate.
The AOTC offers a maximum credit of $2,500 per eligible student.
This may bring the amount you owe in taxes to zero or below zero, in which case you could have up to 40% of the remaining credit amount (up to $1,000) refunded to you.
This credit is similar to the American Opportunity Credit, but it can be applied to postsecondary education, as well as any courses you might take to improve your job skills.
With the Lifetime Learning Credit, you can claim a credit up to a maximum of $2,000. Unlike the American Opportunity Credit, this credit is nonrefundable, which means you won’t get money refunded to you. However, it can significantly reduce the amount you owe on your taxes.
Visit the IRS website to learn more about the eligibility requirements and how to claim the Lifetime Learning Credit on your taxes.
Student Loans and Grants as Income on Credit Card and Loan Applications
Another time you might wisely ask, “Do student loans count as income?” is when you’re applying for a credit card, a loan, or even for a rental apartment, home, or vehicle lease. In this case, student loans or grants being counted as income would act in your favor.
But similarly to the IRS, credit issuers—like banks and online lenders—don’t consider student loans as income. Instead, student loans are seen as debt which must be repaid, while scholarships, grants, and work-study income can be counted as qualified income.
Are Forgiven Student Loans Considered Taxable Income?
Having your student loans forgiven may seem like an all-around great idea. But something that many people don’t consider before applying for forgiveness is the tax implication of having your student loans forgiven.
Originally, your student loans were not taxable as income because they had to be repaid. But if they don’t—or at least a portion of them don’t—have to be repaid, are student loans considered income?
The answer is, unfortunately, yes—in some situations. The IRS considers forgiven student loans taxable income per 26 USC 61 (a) (12) (Cornell Law School). The canceled debt amount has to be reported on an IRS Form 1099-C (IRS.gov instructions) if it’s more than $600.
There are, however, exceptions to this rule including the following:
- Public Service Loan Forgiveness, Teacher Loan Forgiveness, and other types of occupation-dependent forgiveness;
- Death and disability discharges;
- Closed school discharges;
- False Certification Discharge.
If you’re considering student loan forgiveness and you’re not eligible for tax-free loan forgiveness under one of these programs, it’s important to consider how much you will owe in taxes due to student loan discharge. The amount discharged will usually be taxed for the year during which you received the forgiveness.
Step-by-Step Guide to Reporting FAFSA Awards on Your Tax Returns
Even if you know, in theory, what is and is not taxable by the IRS when it comes to your financial aid, filling out your tax returns can be a complicated process. The following is a step-by-step guide for reporting FAFSA college money when tax season comes
Gather all your information.
The first step to making sure you communicate clearly with the IRS is making sure you’re clear, yourself.
Gather all of your FAFSA information, and make a document listing every amount of money you received, when you received it, and what the money went towards (or is currently going towards). Use the NSLDS to get a full view of your student loans. List exact dollar amounts and their sources, and include all of the following:
- Pell Grants;
- Other grants and scholarships;
- Student loans including federal, state and private;
- Earnings from work-study awards; and/or
- State financial awards
This step will not only help you prepare for filing this year’s tax returns, but it will also give you a clearer picture of your FAFSA spending and income, which will aid in budgeting, as well as future FAFSA applications.
Put a check-mark next to these items:
- All grants and scholarships, except Pell Grants;
- Earnings from work-study awards; and/or
- Any Pell Grant amount or state grant amount that is in excess of the amount which you put towards qualifying expenses (tuition, required materials, fees).
These are the amounts that will be included as taxable income on your tax return.
Put an “X” next to these items:
- Pell Grant amounts that go towards qualifying expenses; and/or
- Student loans—both federal and private, as well as state awards.
These are the amounts that you will not include as income on your tax return.
Determine your dependency status.
If it’s your first time filling out your tax return as an adult, you may feel certain you’re an “independent”. But if your parents are claiming you as a dependent on their tax returns, you aren’t eligible to claim certain deductions and credits for yourself.
Your parents can claim you as a dependent until you’re 19, or until you’re 24 if you’re a student. If your parents are claiming you as a dependent, you can still file taxes, but you’ll need to mark that someone else is claiming you as a dependent on their taxes for the year (IRS).
Have a conversation with your parents to determine whether they’ll claim you as a dependent on their taxes, or whether you should claim independent status.
Find out which tax forms you need.
If you’re away at school but your permanent address has stayed the same, tax forms might be sent to your parents’ address. It’s a good idea to watch out for certain documents that you’ll need to file your taxes and ask your parents to do the same if your address is still listed as their house.
Depending on whether you work a job and other factors, you could have one or more of these documents to watch out for:
A W-2 is the standard tax information form sent out by employers. If you had a job this year and didn’t receive a W-2, contact your employer to make sure they sent it to the right address.
If you paid tuition, you should receive this form from your college. Form 1098-T will include information you’ll need to fill out your tax return, including tuition paid, related expenses, scholarships and grants you received, and adjustments from the previous year.
If you paid interest on a student loan this year, you’ll need a Form 1098-E to verify that information on your tax return. You should receive this form if you paid $600 or more in interest over the year. (If you’re a current student, you may not yet be paying off the interest on your student loan, so you wouldn’t need this form.)
Form 8863 is needed if you qualify for education credits like the American Opportunity Credit or Lifetime Learning Credit.
Preparing for Tax Season
The best way to reduce the stress of tax season is getting ahead of the requirements. If you know which amounts of money are going to be taxed as income and which are not, you can safely put away a percentage of that taxable amount for paying taxes later on.
For example, if you have grants and/or scholarships, and you have money in excess of qualified school expenses that you use to pay for other things, like room and board, transportation or personal costs, that left over amount is considered income.
To prepare for tax season in this scenario, you can put 25% of the excess grant money into a savings account as soon as you receive the funds. That 25% will safely cover the income taxes you’ll be expected to pay the following year on that amount.
Summary: Are Student Loans Considered Income?
To summarize, the simple answer to the question is—no. But depending on your situation, you may need to consider other factors, like grants and scholarships, work-study income, and loan forgiveness.
Additionally, it’s always a good idea to be aware of the interest you’re paying on your student loans so that you can make sure to claim those as deductions on your tax return. If you are reading this prior to borrowing and are looking for some other options to student loans, we explain your best options to pay for college.
If you’re still in doubt about what qualifies as income and what doesn’t when it comes to your FAFSA awards, it’s a good idea to visit or contact a tax professional.