A: Generally, all compensation received for services is taxable. Although compensation is usually received in cash, it can be in the form of anything of value, such as property, services, even payments to third parties on your behalf -- in this case, your employer settling your student loan. There's no special tax benefit to an employer for paying an employee's third-party debt. That's merely considered salary, with attendant withholding of payroll taxes.
If the third-party debt is a "qualified education loan," the student may have a "qualified education-loan interest deduction." This deduction is available to the student regardless of whether the employer or the student pays the interest. That's because, even if the employer makes the payments, the student is considered a conduit: the payments are made to the student as salary, and then come from the student as loan-and-interest payments.
"Qualified education-loan interest" is the first 60 months of interest paid on a "qualified education loan" and is available whether the taxpayer itemizes or takes the standard deduction. These are loans incurred solely to pay qualified higher-education expenses at an eligible institution. The student-loan interest deduction is phased out at certain income levels (starting at $40,000 modified adjusted gross income).
[According to the IRS, qualified expenses include tuition and fees, room and board, books and supplies, and transportation. "Eligible educational institution" applies to virtually all accredited public, nonprofit, and private postsecondary institutions. Loans that don't qualify for the interest deduction, according to the IRS, are those from a relative, from an employer plan, or from certain corporations, partnerships, trusts, and exempt organizations. For more information, visit the IRS Web site, www.irs.gov.]
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