Mastering FAFSA: Everything to Know about Taxes and Financial Aid

Let’s say you’ve just taken out your very first loan to help pay for your child’s college education. Or maybe you’re a parent filing for the first time with student loans in repayment. Clearly, it’s time to learn about taxes and financial aid.

We’re not here to nitpick. In fact, there are a ton of unique situations you might find yourself in with regards to student loans and financial aid around tax time. Whatever your exact situation might be, we’re here for you. We welcome you.

So, just do yourself a favor. Don’t be overwhelmed!

Millions of new student and parent borrowers deal with FAFSA each year. And most of them end up taking out some type of student loan financing for the first time. In fact, as of 2018, over 44 million borrowers in the United States owed over $1.5 trillion in student loans.

So, needless to say—you’re not alone.

If you’re new to the world of financial aid, you could be a little shaky come tax season. What’s deductible? What’s taxable? FAFSA does a great job of walking you through the ins and outs of financial aid. But it can still leave some lingering questions about what it all means for your tax return.

With that in mind, we’re here to fill in the gaps. If you’ve recently applied for financial aid, begun repayment on student loans, or are just unsure where to start when it comes to your financial aid and taxes—we’re going to ensure you have a crystal clear picture. Based on your financial aid situation, we’ll walk you through what you can expect around tax time.

The Type of Financial Aid Makes a Big Difference

Financial aid comes in all shapes and sizes.

And not all of it is created equally in the eyes of Uncle Sam. For example, let’s say you’re admitted to a work-study program and work part-time to earn some of your student aid. That’s considered taxable income. On the other hand, Stafford loans aren’t taxable at all. On the other-other hand, Pell grants aren’t taxable at all. At least, assuming you’re using them on things like books, tuition, fees, or supplies.

Think about it like this: Generally, grants are free money, assuming you use them as intended. Loans aren’t taxable because you’re paying them back with interest. And everything else is probably taxed as income. It’s a good rule of thumb, but there are always some exceptions. So pay close attention to FAFSA, your tax preparer, or your child’s financial aid office.

Student Loan Interest Is Deductible

Student loan interest is a blessing and a curse.

For all the frustration that comes along with student loan debt, there’s one bright spot—a silver lining that comes around tax season each year. If this year is yours or your child’s first time repaying student loans, then you have one thing to look forward to: The interest you pay on students loans is deductible!

Typically, your lender will make things very easy for you on your tax documents. They will reflect the total amount you’ve paid in student loan interest, and you’ll then be able to deduct that interest you’ve paid from the total you owe.

Depending on your student loan amounts and the totals you owed in taxes, that number could make a lot bigger difference than you realize! In fact, your student loan interest can add up to hundreds or thousands of dollars off your taxes each year.

Students Should Practice Good Financial Habits

As a student (or a parent guiding your child through their first years away from home), the smartest financial decision you can make is to set a budget and be smart about your finances.

This is why: When your student loans hit your bank account, they can feel a lot like “free money.” It’s tempting to splurge on food, drinks, and nearly anything else! But throughout your college career, your loans will slowly be accruing interest. And once you graduate, you have the chance to pay this interest—or allow it to be added to your principal.

One of the best gifts you can give yourself as a newly graduated college student who is carrying the burden of student loans is to lighten your own burden. Set a smart financial foundation with a solid budget and ask your counselor, financial aid office, or friends to help keep you accountable. Trust us, if you can save even 15% of your loans each semester, you’ll make a huge dent in paying down your debt by the time you graduate.

And wouldn’t paying off your loans a couple years earlier be nice?

Financial Aid and Taxes

For most people, financial aid is about as complicated as taxes. You want to have an expert by your side to help guide you through the process and maximize your benefit while reducing what you owe.

Fortunately, by following a few simple principles, both parents and students alike can navigate through nearly any type of student aid situation during tax season. You may be surprised how much you may end up benefitting on your tax return—or even your refund!