Everything You Need to Know about Financial Aid and Taxes

It’s tax time. You’re a parent who has just taken out your first loan for your child’s college education. Or, perhaps it’s tax time and you’re filing for the first time as a parent with student loans in repayment. That means you need to learn about financial aid and taxes.

We could spend time outlining other examples of parents treading unfamiliar waters regarding student loans and taxes. But we won’t waste your time.

Regardless of your specific situation, we welcome you. Try not to be overwhelmed.

Each year, millions of new students enroll in college. In that group, a majority will take out some form of student loan financing for the first time. That’s why, as recently as 2018, 44.2 million borrowers in the United States owed over $1.5 trillion in student loans. That’s right. Trillion, with a T.

If you’re one of these new borrowers, you may be unsure what all this could mean for your taxes. No matter how much FAFSA explains the basics, it’s easy to miss exactly how financial aid affects your taxes.

Well, we’re here to help. If you’re wondering what FAFSA has to do with your taxes—and what you might be able to expect on your return this year—we’re ready to ensure you have a crystal clear picture. We’re going to walk you through what to remember when filing for financial aid or repaying student loans.

Financial Aid and Taxes

Not all student aid is created equally.

There are a ton of different types of financial aid one can receive, and they’re all weighed in their own ways by the IRS. For example, a Pell grant isn’t considered taxable income at all if it is used as it’s intended—for books, tuition, fees, or equipment. However, if you’re admitted to a work-study program through which you work part-time on campus, that income is considered fully taxable.

Most crucially, any Stafford loans aren’t taxable. So if you or your child has taken out a loan for their college, you’re not expected to report this amount as taxable income. After all, you’ll be paying them back in full—with interest.

As a rule of thumb, grants aren’t taxable if you use them as intended. Meanwhile, loans aren’t taxable regardless. And everything else probably is taxed as income. There’s a lot of variation here from state to state and person-to-person, so it’s always best to follow the lead on FAFSA or ask your accountant or tax preparer.

Repayment Can Mean Big Tax Savings

Student loan interest is a boon and a bane.

If this is your first year repaying student loans on behalf of your child—or if it’s their first year repaying loans—it’s good to know what’s in store. And for all the frustration that comes with student loan debt, you can take solace that at least one time each year, all that money you’ve put toward those student loans will actually help you financially!

The interest you pay on student loans is deductible. Your tax documents will reflect the total you’ve paid in student loan interest, and whether you’re filing by hand, with a tax preparer, or using tax software, you’ll be able to deduct the total interest you’ve paid from your taxes.

Depending on your student loan totals, this number may end up being a lot higher than you think. These totals can add up to hundreds or thousands of dollars off your taxes each year!

A Tip for Students: Use Your Money Wisely

The smartest financial decision you can make as a student (or as a parent guiding your child through their first few years away from home) is to be smart about your finances.

Here’s why: If you’ve taken out loans, the entirety of your time during college will be spent accruing interest on those loans. Once you’ve graduated, you’ll have the opportunity to pay this interest—or have it added to your principal.

When you’re away at college for the first time, it’s easy to spend, spend, spend. And it’s easier when you know you have a few thousand dollars in the bank from Uncle Sam. But set your financial foundation firmly, talk to your counselor or financial aid office about budgeting, and ask your friends to keep you accountable.

You know what’s better than an extra side of fries for the table? Being able to save 20% of your student loans each semester and become debt-free a few years earlier.

Getting Tax Help from FAFSA

Taxes are complicated enough for most people, and adding financial aid to them takes things to another level. Fortunately, there are a few guiding principles that can help both parents and students navigate their way through tax season. Stick to them, and you’ll be surprised how much you can benefit your tax return—and even your refund.

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