How Tax Planning Affects Your 2021 Student Loan Payments

How Tax Planning Affects Your 2021 Student Loan Payments

Tax planning with student loans in thoughts is simply as necessary as a reimbursement plan itself. With the proper planning, you may obtain a better stage of economic effectivity, placing more cash again in your pocket.

Tax submitting standing and marital standing impression your fee if you’re on an income-driven reimbursement (IDR) plan. Tax planning is extra necessary than ever this 12 months for the reason that coronavirus pandemic has considerably affected earnings and unemployment in each state, trade and main demographic group within the U.S.

Many debtors have been capable of benefit from student loan fee aid by way of the CARES Act student loan fee pause and 0% curiosity since March 13, 2020. President Biden’s transition crew introduced it would prolong the fee and curiosity freeze on federal student loans once more, which was set to run out on January 31, 2021. It didn’t say how lengthy it will prolong these protections, nevertheless, so we’re (but once more) in limbo.

By the time this text is printed, we’d know the brand new expiration date. What I’m much more taken with is steerage on what is going to occur with recertification due dates.

Annual recertification of earnings

When a borrower is on an IDR plan, they need to replace their month-to-month fee based mostly on earnings each 12 months by on their plan anniversary date. This is known as annual recertification of earnings, or just recertification.

Your recertification due date — or anniversary — is discovered via your support knowledge obtain on StudentAid.gov OR by way of your servicer’s web site or previous recertification correspondence.

Student Aid’s on-line recertification software hyperlinks again to your most just lately filed tax return to confirm earnings by way of the IRS Data Retrieval Tool. This can both enhance or lower your fee relying on what earnings was used to derive your fee the 12 months earlier than.

Calculating your discretionary earnings

It’s not a secret how they calculate your fee. It’s simply an annoying math equation to search out your discretionary earnings which is what your fee is predicated on.

Calculating your discretionary earnings begins together with your adjusted gross earnings (AGI) which is your gross earnings minus any above the road deductions equivalent to pre-tax retirement or HSA contributions or the student loan curiosity deduction.

Try it: Calculate your student loan curiosity deduction

Adjusted Gross Income will be discovered in your IRS type 1040: line 11 for the 2020 tax 12 months; line 8a from 2019. So why does AGI matter?

Well if 2020’s AGI is greater than 2019’s, your fee will go UP when funds resume. If AGI was decrease in 2020 than 2019, your fee might go DOWN.

Waiting for IDR recertification steerage

No one has been required to recertify earnings between 3/13/2020 and 1/31/2021, no matter whether or not their recertification date would have occurred throughout that point. As a part of the fee suspension, recertification dates had been pushed out from their unique recertification dates.

Originally, Student Aid’s steerage was that recertifications for many who’s due date fell between March 13, 2020 to December 31, 2020 could be postponed by 12 months. So in case your unique due date was April 1, 2020, your new recertification date could be April 1, 2021.

Now Student Aid’s steerage reads:

You won’t must recertify your earnings earlier than Jan. 31, 2021, no matter whether or not your recertification date would have occurred previous to Jan. 31, 2021. As a part of the fee suspension, your recertification date has been pushed out out of your unique recertification date.

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You will probably be notified of your new recertification date earlier than it’s time to recertify. If you have got moved, modified cellphone numbers, or have a brand new electronic mail tackle, you must contact your loan servicer to supply up to date contact info.”

So it’s not clear if there’s one other recertification due-date push and for a way lengthy.

Taxes and strategic IDR recertification

Remember, if you’re recertifying your earnings, making use of for a brand new reimbursement plan, or recalculating your IDR fee, the applying is linked again to your most just lately filed IRS tax return. As of this writing, that’s the 2019 tax return for most people since many haven’t filed their 2020 tax 12 months but.

If you’re pursuing Public Service Loan Forgiveness (PSLF) or taxable forgiveness, your objective is to maintain your funds as little as attainable to maximise loan forgiveness. If timing permits, strategically utilizing a decrease tax return to calculate your fee may help you obtain that objective of holding your funds as little as attainable, for so long as attainable.

If you’re in want of tax assist, take a look at our pals at Student Loan Tax Experts. Do a free 15 min chat, and if you find yourself hiring them you would get a reduction on their providers for being an SLP reader.

Recertification instance 1

A borrower is pursuing PSLF. Assume they’d an April 1, 2020 recertification due date that was postponed to April 1, 2021 as a result of CARES Act.

Scenario 1: 2019’s AGI was decrease than 2020. They can nonetheless recertify utilizing 2019’s earnings in the event that they haven’t filed a 2020 return but. This retains their fee decrease, for longer, when funds resume.

Scenario 2: 2020’s AGI was decrease than 2019. Recertification notices are obtained 60 to 90 days upfront. Prior to their April 1, 2021 due date, they will file 2020’s taxes and THEN full their annual recertification linking the applying again to their decrease 2020 tax return to maintain their fee as little as attainable.

Recertification instance 2

A borrower’s recertification due date is October 1, 2020. The CARES Act initially postponed this due date by 12 months to October 1, 2021. Assuming funds resume in February 2021, their pre-pandemic fee would resume till they’d must recertify, which might then recalculate their fee off of 2020’s earnings, if filed.

Without steerage on annual recertification due dates, although, strategically planning this out may very well be difficult. And as soon as steerage is obtained, it could be too little, too late to optimize something.

What must you do?

If 2020’s AGI was decrease for you than 2019, file your taxes, usually. When you’re required to recertify, the fee will probably be based mostly off of that decrease 2020 tax return.

If 2019’s AGI was decrease and your recertification date is generally earlier than April 15, however you haven’t obtained any instruction to recertify, maintain off on submitting 2020 taxes till you completely must so you may nonetheless attempt to hyperlink again to 2019 ASAP. You can at all times file a tax submitting extension, too, if wanted.

Marriage & tax submitting standing: the way it impacts your IDR fee

Things get somewhat tough when a borrower on an IDR plan is married as a result of, in contrast to another debt on the market, federal student debt fee calculations are impacted by your tax submitting standing and your partner’s federal loans, if relevant.

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How so, you ask?

Scenario 1: If you’re married, and your partner doesn’t have student loan debt, then the next fee modifications might occur based mostly in your tax submitting technique:

  • If you file taxes collectively: Your fee is predicated in your joint, adjusted gross earnings.
  • If you file taxes individually: Your fee is predicated by yourself earnings except you’re on REPAYE, which counts joint earnings no matter the way you file taxes together with your partner.
  • If you file taxes individually AND reside in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin: Your fee is predicated on a 50/50 cut up of your family earnings if submitting by way of neighborhood property guidelines on IRS type 8958. See extra notes on this beneath.

Scenario 2: If you’re married, and your partner additionally has student loan debt, then the next fee modifications might occur based mostly in your tax submitting technique:

  • If you file taxes collectively: Your fee is predicated on joint, adjusted gross earnings, however is split proportionally between your respective balances. For instance, let’s say you owe $25,000 and your partner owes $75,000. You’ll have 25% of the family month-to-month fee calculation and your partner can have 75%.
  • If you file taxes individually: Your fee is predicated by yourself respective incomes except you might be on REPAYE, which counts joint earnings no matter the way you file. Each partner’s fee is calculated in proportion to their debt quantity. Filing individually may even depend the poverty line deduction on your family measurement twice, as a result of every of you report it individually.
  • If you file taxes individually and reside in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin: Your fee is predicated on a 50/50 cut up of your family earnings if filed by way of neighborhood property guidelines on IRS type 8958. It additionally counts the poverty line deduction on your family measurement twice.
  • Things can get much more fascinating should you file individually and also you’re candidate for the double-debt loophole.

What to look at for when submitting individually

Filing individually generally is a nice technique to assist cut back your month-to-month fee and obtain cash-flow effectivity. Just a few indicators to search for when deciding should you ought to file individually are:

  1. You’re on observe for PSLF or taxable loan forgiveness, and your objective is to attenuate your fee as a lot as attainable to maximise your forgiveness.
  2. You and your partner hold your funds separate and/otherwise you alone are liable for your student loan debt.
  3. You (and your partner) can’t afford a better month-to-month fee if spousal earnings is factored in.
  4. You need optimum fee effectivity to maximise money move.

Filing taxes individually is just not common

There are only a few circumstances when submitting taxes individually out of your partner makes monetary sense. It’s common on your licensed public accountant (CPA) to boost an eyebrow should you ask about submitting individually for student loan functions.

What must be defined is that submitting taxes collectively whereas solely you have got student loans on an IDR plan can elevate your month-to-month fee considerably and throw off your student loan reimbursement technique.

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There’s a “crossover point” to search for. If the distinction between submitting collectively versus individually prices you lower than the associated fee financial savings of your month-to-month fee submitting individually over the course of the 12 months, then you have got the inexperienced mild on submitting individually.

Tax planning for residents of neighborhood property states

Living in a neighborhood property state has a novel benefit when submitting taxes individually out of your partner. Using the IRS tax Form 8958, the full family earnings is cut up in half, lowering the tax implication of submitting individually, considerably.

Traditionally, married {couples} file taxes collectively. There aren’t a number of circumstances that make submitting individually extra advantageous from a tax perspective over submitting taxes collectively even in neighborhood property states. Your CPA — even when aware of neighborhood property state legal guidelines — may not know to divide earnings appropriately in the event that they’re not aware of IRS Form 8958.

I see errors with this situation most of the time. If you get your tax return again and your neighborhood property 50/50 cut up wasn’t achieved appropriately, it’s essential to repair it to keep away from pointless tax prices. If you’ve been submitting incorrectly, you may amend your tax returns way back to three years to recoup any tax overpayment. Just be sure you don’t amend the newest tax return you would possibly want for recertification quickly.

Downsides to submitting taxes individually for student loan functions

Keep in thoughts there can nonetheless be downsides to submitting taxes individually that you must consider to make sure that your fee’s value financial savings aren’t eroded by the potential penalties of submitting individually. These are the issues you would be giving up (if relevant):

  • Education credit or student loan curiosity deduction of $2,500 — this may not be relevant to you, nevertheless, when you’ve got a modified AGI between $140,000 and $170,000 as a married couple
  • More advantageous tax brackets, except you’re in a neighborhood property state
  • Child care tax credit
  • Earned earnings tax credit
  • Exclusion or credit for adoption bills
  • Ability to contribute to a Roth IRA, although you may nonetheless make the most of the back-door Roth conversion methodology
  • Ability to deduct rental property losses
  • Ability to take the usual deduction in case your partner itemizes, or vice versa

Feel overwhelmed? Not positive what the very best technique is for you and your partner? Schedule a session with me on your custom-made student loan reimbursement plan.

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