How Tax Planning Affects Your 2022 Student Loan Payments

Tax planning with student loans in mind is just as important as a repayment plan itself. With the right planning, you can achieve a higher level of financial efficiency, putting more money back in your pocket.

Tax filing status and marital status impact your payment when you’re on an income-driven repayment (IDR) plan. Tax planning is more important than ever. The coronavirus pandemic has significantly affected income and unemployment in every state, industry and major demographic group in the U.S.

Many borrowers benefited from student loan payment relief via the student loan payment pause and 0% interest. President Biden’s team extended the federal payment and interest freeze, which will now expire on August 29, 2023.

Let's look at how your taxes and student loan payments go hand-in-hand.

Annual recertification of income

When a borrower is on an IDR plan, they must update their monthly payment based on income every 12 months by their plan anniversary date. This is known as annual recertification of income, or simply recertification.

Your recertification due date — or anniversary — is available through your aid data download on StudentAid.gov OR via your servicer’s website or past recertification correspondence.

Student Aid’s online recertification application links back to your most recently filed tax return to verify income via the IRS Data Retrieval Tool. This can either increase or decrease your payment depending on what income was used to derive your payment the year before.

Related: To Link or Not to Link: Guide to IRS Automatic Income Sharing for Student Loans Repayments

Calculating your discretionary income

It’s not a secret how they calculate your payment. It’s just an annoying math equation to find your discretionary income, which is what your payment is based on.

Calculating your discretionary income starts with your adjusted gross income (AGI). This is your gross income minus any above-the-line deductions. For example, pre-tax retirement or health savings account (HSA) contributions or the student loan interest deduction.

Try it: Calculate your student loan interest deduction

Your AGI is found on your IRS form 1040: line 11 for the 2021 and 2020 tax years. So why does AGI matter?

Well normally, if 2021’s AGI is higher than 2020’s, your payment will go UP when payments resume. If AGI was lower in 2021 than 2020, your payment could go DOWN.

However, the COVID payment pause temporarily locks in your previous payment. The Department of Education states that your payment amount will return to what it was before your payments were paused (unless you've recertified or switched plans since the pause began).

So, once you recertify, the normal rules apply.

Waiting for IDR recertification guidance

No one has been required to recertify income between March 13, 2020, and August 29, 2023, regardless of whether their recertification date would have happened during that time. As part of the payment suspension, recertification dates had been pushed out from their original recertification dates.

Student Aid’s guidance reads:

“You won’t be required to recertify before payments restart, and the earliest you could be required to recertify is November 2022.

You may still see a recertification date that is earlier than November 2022 on your account Aid Summary. We are working to get those updated, and we thank you for your patience. If your recertification date falls between now and November 2022, it will be pushed out by one year. For example, if your account says your recertification date is Oct. 1, 2022, that date will be pushed out to Oct. 1, 2023.“

If you aren't sure of your recertification date, contact your loan servicer for the most up-to-date information.

Taxes and strategic IDR recertification

Remember, when you’re recertifying your income, applying for a new repayment plan, or recalculating your IDR payment, the application is linked back to your most recently filed IRS tax return. As of this writing, that’s the 2020 tax return for most folks since many haven’t filed their 2021 tax year yet.

If you’re pursuing Public Service Loan Forgiveness (PSLF) or taxable forgiveness, your goal is to keep your payments as low as possible to maximize loan forgiveness. If timing allows, strategically using a lower tax return to calculate your payment can help you achieve that goal of keeping your payments as low as possible, for as long as possible.

Check out our friends at Student Loan Tax Experts if you're in need of tax help. Do a free 15 minute chat. If you end up hiring them, you could get a discount on their services for being an SLP reader.

Recertification example

A borrower is pursuing PSLF. Their recertification due date was postponed to November 2022 or later due to the CARES Act and payment extensions.

Scenario 1: 2020’s AGI is lower than 2021. They can still recertify using 2020’s income if they haven’t filed a 2021 return yet. This keeps their payment lower, for longer, when payments resume.

Scenario 2: 2021’s AGI is lower than 2020. Recertification notices are received 60 to 90 days in advance. They can complete their annual recertification linking the application back to their lower 2021 tax return. This will keep their payment as low as possible.

What should you do?

If 2021’s AGI is lower for you than 2020, file your taxes, normally. When you’re required to recertify, the payment will be based on that lower 2021 tax return.

If 2021’s AGI is higher than the previous two years, don't recertify (or submit updated income information) until you have to. Your recertification date will be November 2022 at the earliest. So, you can benefit from keeping your lower monthly amount from before the payment pause began.

Marriage & tax filing status: How it impacts your IDR payment

Things get a little tricky when a borrower on an IDR plan is married. Unlike any other debt out there, federal student debt payment calculations are impacted by your tax filing status and your spouse’s federal loans, if applicable.

How so, you ask?

Scenario 1

You’re married, and your spouse doesn’t have student loan debt, then the following payment changes could happen based on your tax filing strategy:

• If you file taxes jointly: Your payment is based on your joint, adjusted gross income.
• If you file taxes separately: Your payment is based on your own income unless you’re on REPAYE, which counts joint income regardless of how you file taxes with your spouse.
• You file taxes separately AND reside in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin: Your payment is based on a 50/50 split of your household income if filing via community property rules on IRS form 8958. See more notes on this below.

Scenario 2

You’re married, and your spouse also has student loan debt, then the following payment changes could happen based on your tax filing strategy:

• If you file taxes jointly: Your payment is based on joint, adjusted gross income, but is divided proportionally between your respective balances. For example, let’s say you owe $25,000 and your spouse owes $75,000. You’ll have 25% of the household monthly payment calculation and your spouse will have 75%.
• If you file taxes separately: Your payment is based on your own respective incomes unless you are on REPAYE, which counts joint income regardless of how you file. Each spouse’s payment is calculated in proportion to their debt amount. Filing separately will also count the poverty line deduction for your household size twice, because each of you report it separately.
• If you file taxes separately and reside in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin: Your payment is based on a 50/50 split of your household income if filed via community property rules on IRS form 8958. It also counts the poverty line deduction for your household size twice.
• Things can get even more interesting if you file separately and you’re a good candidate for the double-debt loophole.

What to watch for when filing separately

Filing separately can be a great strategy to help reduce your monthly payment and achieve cash-flow efficiency. A few indicators to look for when deciding if you should file separately are:

1. You’re on track for PSLF or taxable loan forgiveness, and your goal is to minimize your payment as much as possible to maximize your forgiveness.
2. You and your spouse keep your finances separate and/or you alone are responsible for your student loan debt.
3. You (and your spouse) can’t afford a higher monthly payment if spousal income is factored in.
4. Your household wants optimal payment efficiency to maximize cash flow.

Filing taxes separately is not usual

There are very few circumstances when filing taxes separately from your spouse makes financial sense. It’s not unusual for your certified public accountant (CPA) to raise an eyebrow if you ask about filing separately for student loan purposes.

What needs to be explained is that filing taxes together while only you have student loans on an IDR plan can raise your monthly payment significantly and throw off your student loan repayment strategy.

There’s a “crossover point” to look for. If the difference between filing jointly versus separately costs you less than the cost savings of your monthly payment filing separately over the course of the year, then you have the green light on filing separately.

Tax planning for residents of community property states

Living in a community property state has a unique advantage when filing taxes separately from your spouse. Using the IRS tax Form 8958, the total household income is split in half, reducing the tax implication of filing separately, significantly.

Traditionally, married couples file taxes jointly. There aren’t a lot of circumstances that make filing separately more advantageous from a tax perspective over filing taxes jointly even in community property states. Your CPA — even if familiar with community property state laws — might not know to divide income correctly if they’re not familiar with IRS Form 8958.

I see mistakes with this issue more often than not. If you get your tax return back and your community property 50/50 split wasn’t done correctly, you need to fix it to avoid unnecessary tax costs. If you’ve been filing incorrectly, you can amend your tax returns as far back as three years to recoup any tax overpayment. Just make sure you don’t amend the most recent tax return you might need for recertification soon.

Downsides to filing taxes separately for student loan purposes

There can still be downsides to filing taxes separately. You should evaluate your options to ensure your payment’s cost savings aren’t eroded by the potential consequences of filing separately. These are the things you could be giving up (if applicable):

• Education credits or student loan interest deduction of $2,500. However, this might not apply if your modified AGI is between $140,000 and $170,000 as a married couple.
• More advantageous tax brackets, unless you’re in a community property state.
• Ability to contribute to a Roth IRA, though you can still utilize the back-door Roth conversion method.
• Child care tax credit.
• Earned income tax credit.
• Exclusion or credit for adoption expenses.
• Ability to deduct rental property losses.
• Ability to take the standard deduction if your spouse itemizes, or vice versa.

Feel overwhelmed? Not sure what the best strategy is for you and your spouse? Schedule a consultation for your customized student loan repayment plan.