Savanna Hoffman
Student loan debt is a significant issue in the United States, with over $1.6 trillion in student debt. While there are various income-based repayment plans and tax breaks available, some question why student loan payments are not allowed pre-tax. In March 2020, the IRS introduced an option for employers to include student loan repayment assistance as part of their Educational Assistance Programs, allowing employees to benefit from tax-free contributions of up to $5,250 per year towards their student loans. This option has been extended beyond its initial sunset date of December 31, 2025, and made permanent by the One Big Beautiful Bill.
| Characteristics | Values |
|---|---|
| Can I pay my student loans pre-tax? | No, but employers can provide tax-free assistance with employee student loan repayments until December 31, 2025. |
| How much can employers contribute tax-free? | Up to $5,250 per employee per year. |
| What are the benefits of the employer contribution? | It is not considered taxable income for the employee and can be excluded from federal withholding, Social Security, Medicare and Federal FUTA tax. |
| What are the requirements for the loan to qualify for repayment? | The loan must be taken out to pay for qualifying education expenses incurred within a reasonable period of time before or after taking out the loan for an eligible student. |
| Are there any tax rules that affect student loan borrowers? | Yes, there are tax breaks and income-based repayment plans that can provide relief. For tax years 2024 and 2025, up to $2,500 of paid interest can be written off. |
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What You'll Learn
Student loan interest deduction
The student loan interest deduction is a federal income tax deduction that allows borrowers to deduct up to $2,500 of the interest paid on qualified student loans from their taxable income. This deduction is available to students and their parents who took on debt to pay for higher education. It is one of several tax breaks available to help make higher education more affordable.
To claim the student loan interest deduction, individuals must meet specific eligibility criteria. Firstly, their filing status must be any status other than "married filing separately." Secondly, no one else can claim them as a dependent on their tax return. Thirdly, they must be legally obligated to pay interest on a qualified student loan. Finally, they must have paid interest on a qualified student loan in the tax year for which they are filing. It is important to note that the student loan interest deduction is subject to a phase-out based on filing status and income level. For single filers, the modified adjusted gross income (MAGI) must be less than $80,000, while for those filing jointly, the MAGI must be less than $165,000. If the MAGI exceeds these thresholds, the deduction amount is gradually reduced until it is eliminated.
To claim the deduction, individuals will need to obtain Form 1098-E, the Student Loan Interest Statement, from their lender if they paid more than $600 in interest during the tax year. This form will be provided automatically by the lender in most cases. Individuals can then use the IRS's student loan interest deduction worksheet to calculate their deduction amount and enter that amount in Schedule 1 of Form 1040. It is important to note that this deduction is only available for payments made after March 27, 2020, and until December 31, 2025, according to the current law.
In addition to the student loan interest deduction, there are other ways to pay student loans pre-tax. One option is through an employer's Educational Assistance Program. Employers can establish these programs to allow employees to repay their student loans with pre-tax dollars, excluding up to $5,250 per year from their income. This option is available until December 31, 2025 and can provide significant financial benefits to employees.
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Tax-free employer repayment
In March 2020, the IRS established the option for employers to include, in a qualifying Educational Assistance Program, the ability of employees to pay back their college loans with pretax dollars. This provision is set to expire on December 31, 2025. Under this provision, employers can contribute up to $5,250 towards an employee's student loans on a tax-free basis. This amount can be excluded from federal withholding, Social Security, Medicare, and Federal FUTA tax.
The IRS Code Section 127 states that employers who have educational assistance programs can use them to help pay student loan obligations for their employees. These programs can be used to pay principal and interest on an employee's qualified education loans. Payments can be made directly to the lender or to the employee.
The tax-free benefit for student loan repayment was introduced as part of the CARES Act. It has since been made permanent as part of the One Big Beautiful Bill Act, with adjustments for inflation starting in 2026. This change is expected to lead to more companies offering student loan reimbursement benefits to their employees.
Employers can consider setting up an Educational Assistance Program to take advantage of this benefit and enhance their recruitment initiatives.
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Tax breaks
In 2020, the IRS established the option for employers to include, in a qualifying Educational Assistance Program, the ability for employees to pay back their college loans, including principal and interest, with pretax dollars. This means that employers can now provide tax-free assistance with employee student loan repayments. This option is currently available until December 31, 2025, and there is a maximum annual exclusion of $5,250 per employee.
This tax-free benefit is especially beneficial for employees, as it can be excluded from federal withholding, Social Security, Medicare, and Federal FUTA tax. Additionally, employers can make payments directly to the employee or the student loan lender.
While this option provides a valuable opportunity for employees to save money on their student loan repayments, it is important to note that not all employers offer this benefit. As of 2023, 34% of employers offered this benefit, up from 17% in 2021.
Aside from employer-provided tax breaks, individuals with student loan debt may also be eligible for certain tax breaks, such as the student loan interest deduction. For tax years 2024 and 2025, individuals can write off up to $2,500 of paid interest. However, it is important to note that not everyone is eligible for this deduction, as there are income limits and phase-outs that vary depending on the filing status.
Furthermore, individuals repaying student loans may also qualify for education-related tax credits, such as the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). These credits aim to offset the expenses of higher education but cannot be used directly towards student loan payments.
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Income-based repayment plans
Since March 2020, employers have been able to include in a qualifying Educational Assistance Program (see IRS Code Section 127) the ability for employees to pay back their college loans, including principal and interest, with pretax dollars. This option is currently available until December 31, 2025. Under current law, tax-free benefits under an educational assistance program are limited to $5,250 per employee per year.
Educational Assistance Programs are typically used to pay for books, equipment, supplies, fees, tuition, and other education expenses for the employee. However, they can now also be used to pay principal and interest on an employee's qualified education loans. Payments made directly to the lender, as well as those made to the employee, qualify.
It is important to note that with the use of this benefit, one cannot also claim the interest deduction. This benefit is an excellent opportunity for employers with a recent college graduate workforce to enhance their recruitment initiatives.
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Tax-free threshold
In March 2020, the IRS established the option for employers to include, in a qualifying Educational Assistance Program (see IRS Code Section 127), the ability of employees to pay back their college loans, including principal and interest, with pretax dollars. This means that employees can exclude up to $5,250 per year from their income if used to pay back their student loans. This exclusion applies to federal withholding, Social Security, Medicare, and Federal FUTA tax. The option is currently available until December 31, 2025.
It is important to note that this benefit cannot be used in conjunction with the interest deduction. Additionally, any interest paid by an employer under an educational assistance program after March 27, 2020, and before January 1, 2026, cannot be deducted as interest on a student loan.
Some people have argued that not allowing pre-tax payments on student loans disproportionately favors high-income groups. If pre-tax payments were allowed, a family with a high income could incentivize their child to take out loans to pay for college. At the end of college, the family could cut a check to pay off the loans, and the pre-tax payment would lower their income for that year, resulting in tax savings. On the other hand, a lower-income family would not see as much benefit from this strategy.
There are also concerns that allowing pre-tax payments on student loans could lead to tax avoidance. If there were no limits on the amount that could be paid pre-tax, individuals could borrow large amounts and then repay them with untaxed money, essentially washing their income of taxes.
While pre-tax payments on student loans are not currently allowed in most cases, there are other tax benefits available for education, such as the student loan interest deduction and tax-free scholarships or fellowship grants. Individuals can refer to IRS publications and forms, such as Publication 970, Tax Benefits for Education, and Form 1040, to determine if they qualify for any education-related tax benefits.
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Frequently asked questions
Yes, you can pay your student loans pre-tax through your employer if they offer an Educational Assistance Program. This option is available until December 31, 2025, unless future legislation extends the deadline.
Employers can provide tax-free financial assistance to employees for certain education expenses, including student loan repayments.
Employers can contribute up to $5,250 per employee per year towards student loan payments.
No, the amount received from your employer (up to $5,250) does not need to be included in your income. Any amount over $5,250 should be included in your income and will be subject to taxes.
Yes, there are other tax breaks and income-based repayment plans that can provide relief. For example, for tax years 2024 and 2025, you can write off up to $2,500 of paid interest on your student loans.
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