Dental Student Loans: Tax Consequences

All right, associates, let's talk about the tax consequences of your student loans. There's really, it's not a terribly complicated set of rules around student loans. Believe it or not, even though the tax code can be extremely complicated, it's fairly straightforward here with student loans. The first point I want to make is that the interest point portion of your student loan is tax deductible if your income is below a certain level. In one of our prior modules, we spoke about the basics of a loan and what an amortization schedule is, which outlines how each of your payments is broken up between principal and interest. Well, remember this, that throughout your entire life, whenever you pay back principal on any debt, business or otherwise, you do not get a tax deduction on paying the principal portion of your debt. Never. Why? Because that's not an expense. You're just paying somebody back money for having given you that money. That is not in a. It's not an administrative expense, it's not an operating expense. It's simply paying somebody back. However, the interest portion is an expense because you're paying somebody to have lent you that money. And so in business, if you get a practice purchase loan, the interest portion on that is always going to be tax deductible. Now, there are some expenses that get phased out, meaning you cannot get a tax deduction. If your income is too high, that deduction phases out. When I say deduction, I simply mean.

The offset against your income, thereby lowering your taxable income and lowering your taxes. You want deductions that is really good for taxes. A tax deduction lowers the income that you pay taxes on and therefore how much you pay in taxes. So you want this to be tax deductible, the interest. However, with your student loans, if you make under a certain amount, yes. If you make over a certain amount, no. Let's look at the table. As of 2019, 2020, this will edge up a little bit each year. Typically not dramatic changes unless they have a complete overhaul of this. But it's been pretty stagnant for many, many years. Other than a little sort of inflation increase periodically. If you are filing as a single person, you're not married and you make less than $70,000, great. Then you can get a full deduction on your interest. However, you did not go to dental school and suffer all of those long hours and arduous experiences in classroom and doing the dentistry so that you can earn less than 70,000. I don't mean to speak or belittle anybody who makes less than 70,000, but not anybody goes through all those arduous years of dental school or has hundreds and hundreds of thousands of dollars of student debt. So that's why I say for most dentists, you're not going to get a tax deduction for the interest portion of your student loan. At 70,000 bucks it starts to phase out. And at 85,000 bucks, you get 0 of income. Magi stands for your modified adjusted gross income. Don't worry about exactly what that means. Let's just say your income. To keep it simple. If you're married, then you got a little bit more. Actually you've got twice you got $140,000 if you're married, of income, meaning you can have income of $140,000 or less. So if you're out of school and you have maybe a stay at home spouse who's not working, it's very possible you may earn less than 140,000, in which case you would get a deduction on the interest portion of your student loans.

Excuse me. Now, if you're on an IDR plan, most likely all of your payment is going toward interest. If you remember that discussion we had about accrued interest versus capitalized interest and your payment isn't even covering the interest portion of your student loan, then all that's going to be tax deductible. If married filing joint, you're under 140,000. Once you hit though 170,000, then you completely phase out of it between 140 and 170, you'll get some deduction for the interest. You might get 50% or 70%. If you do married filing separate, you're not going to get any interest no matter what your income is. And we had spoke about marrying filing separate under the different types of IDR plans and how under a pay option, pay as you earn option, you can file your tax return separately from your spouse. Married filing separate not have to include your spouse's income when calculating what your 10% income is for determining your cap on your payment with repay. However, no matter how you file, you're always going to include your spouse. Well, that might be the only time where we have a conflict here is if you make, if you're married and you're making combined with your spouse, 140,000 or so, or let's say no 200,000 and you want to exclude your spouse's income, you can't go and file married filing separately and get a tax deduction on the student loans. You may be trying to do that in order to have a lower repayment on the pay option, but it may not be good for tax purposes. So you have to look at that sort of in conjunction with each other. Typically. I'm not a huge fan of married filing separate for reasons like this. There's other areas in the tax code where you lose some benefits when you do married filing separate. There are extenuating circumstances where that might make sense. And talking to a practice CFO advisor or your CPA who understands student loans and this kind of thing can help out. The next point I want to mention is that a lot of people buy their practice and in their practice they will, they think, okay, I'm going to make my payments my student loan through my corporation. Or if you have an LLC through your LLC account, you know, most LLC file as a corporation, follow that module as well. Or if you're sole proprietor, which we don't typically don't recommend, definitely don't recommend being a C Corp. But whatever your business structure is, if you pay your student loans out of your business account instead of your personal account, guess what? That doesn't make it tax deductible. That would be fraudulent tax. That would be tax evasion they call it, because the government is incredibly clear on this, that you cannot get a tax deduction on your student loan payments beyond what you see here in our on our presentation. And so don't try to be sneaky on that. Just make your student loan payments out of your personal account and just plan on not getting a tax deduction on it through your business. The next thing is you cannot use home equity or even practice debt to pay off your student loan and receive a tax deduction. So let me rephrase that and I'm going to adjust that a little bit. You can use your home equity and sometimes it's a good idea. You can use your home equity to pay off a student loan, or you can use cash in the practice to pay off your student loan, but you're not going to receive a tax deduction for doing that. And they used to have old rules around using up to $100,000 of home equity. You still get a tax deduction for it and you go pay off your student loans. Well, they've changed that recently under the Trump administration. Tax changes, among a lot of other changes there.

Now also important, if you have extra cash in your account, let's say you buy a practice, you get $100,000 of working capital plunked in your account as your just in case money to sort of get you through the early period and then let's say after a year you're thinking, okay, my practice is safe and sound. I'm still sitting on that working capital that the bank gave me. I'm going to take that $100,000 out and I'm going to go pay off my student loan with it. There's going to be some tax traps there that you can't just go pull out money that you didn't earn from your practice into your personal life to pay off some other debt. And it creates this thing called excess distributions or what's called a loan to shareholder, which we talk about both of those in our tax modules. And these are all very important common scenarios and key tax terms that you're going to have to understand in your early years as a practice owner. So my bottom line here is don't plan on taking money out of your practice to pay off your student loan unless it's money you actually earned in your practice and you built up some cash because you've been running your practice well and living on a budget personally. Then you can take that off out and pay your student loans. But don't take any sort of line of credit from a bank or working capital loan from a bank and go pay off your student loans. And the last comment on the tax implications here of student loans is that any debt that's forgiven under your IDR plan, whether that's ibr, pay, repay or hopefully not. But ICR is taxable as of today under the ordinary tax rates. Now you may know this, but there's long term capital gain rates which are taxed at a lower rate, typically 15 or 20%. And then there's your ordinary tax rates. And in our tax module, be sure you watch our tax module to talk about how the tax schedule works as a progressive or tiered tax table, you might be what's called a marginal tax rate, that sort of tax bracket that you're in at a 30% federal and a 5% state, that's 40%. And any debt that's forgiven on your student loan is going to be taxed at that higher rate. Except for your PSLF loans, those are not taxable. That discharged debt, that forgiven debt is not taxed to you for the PSLF, but the IBR pay, repay and ICR it is as of today, 2020. Now I promise you, if you're watching this three or four years from now, there's probably going to be some changes to the student loan landscape. They've already had legislation to combine all of the IDR programs into one call it. IBR1 was the term. It failed through Congress. But there's a lot of emphasis on this in the halls of government, because we are at $1.6 trillion of student loans right now, with only around 50% of those being paid back. And this large forgiveness on the horizon over the next 10, 15, 20 years, it's really going to hurt the government's balance sheet, meaning that's not going to look good to their finances. And so there's a lot of discussion around changes around these student loans, what's going to be forgiven, the tax implications, et cetera. So stay tuned for that. But these are the main implications on the tax effects on your student loan payments.