As the cost of a college education continues to climb, more and more students are taking on student debt. Collectively, as a country, we currently owe nearly $1.4 trillion in student loans. That balance is growing at a rate of $2,726.27 every second.
To help ease the pain of paying off all of that debt, Congress has made it tax favorable. That hasn’t always been the case: beginning in 1986, you couldn’t claim a deduction for interest paid for personal reasons (one glaring exception being the home mortgage interest deduction). However, in 1997, as part of the Taxpayer Relief Act of 1997, interest paid for student loans was deemed to be deductible. For more on the history of student loans, check out this prior post.
Today, there is a deduction allowed for paying interest on a student loan used for higher education. The student loan interest deduction is available even if you don’t itemize. It’s technically an adjustment to income but is sometimes called an “above the line” deduction since you reduce your taxable income on the front page of your return without regard to any deductions claimed on a Schedule A.
Of course, there are rules. This is tax law. There are always rules.
First, there is a cap on the amount of interest you can claim each year. You can reduce your income subject to tax by up to $2,500 of qualified student loan interest annually per tax return (that means that the cap remains the same for married couples). This amount includes both required and voluntary interest payments – it’s not just what the loan folks want you to pay. The more you pay, the more you can deduct, assuming you don’t go over the cap.
Next, your student loan must have been taken out solely to pay qualified education expenses. This includes tuition and fees; books, supplies, and equipment; and other necessary expenses such as transportation. Room and board may also be included if the cost is not more than the allowance for room and board included in the cost of attendance at your school for federal financial aid purposes or the actual amount charged if you live in housing owned or operated by your school.
Now read this part carefully: the loan does not have to come solely from PHEAA or another institutional student loan provider. You can include other debt, such as credit cards and line of credit if you use it only to pay student debt (don’t commingle). Bank and other loans also qualify, but the borrowed funds cannot be from a related person or made under a qualified employer plan.
For purposes of the deduction, the student who borrowed the funds must be you, your spouse, or your dependent, and must have been enrolled at least half-time in a degree program when the loan was taken. And don’t get your terms confused! For purposes of the deduction, an individual can be your dependent even if you are the dependent of another taxpayer; even if the individual files a joint return with a spouse, and even if the individual had gross income for the year that was equal to or more than the exemption amount for the year.
As with other education tax breaks, you must reduce your qualified education expenses by the total amount paid for employer-provided educational assistance; Tax-free distribution of earnings from a Coverdell education savings account or a qualified tuition program (QTP); U.S. savings bond interest previously excluded from income; tax-free scholarships, fellowships and grants; and veteran’s benefits.
You can typically deduct all of the interest you paid on your student loan until the loan is paid off. There are limits and phaseouts, however, depending on your income. The student loan interest deduction is phased out (reduced) if your modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return). For most taxpayers, MAGI is the adjusted gross income (line 37) on their federal income tax return before subtracting any deduction for student loan interest. Additionally, you may not deduct your student loan interest if you file as married filing separately or if someone else claims an exemption for you on his or her tax return.
And one more thing (this is the best part!): if someone else makes a payment on your behalf, you are treated for federal income tax reasons as though you made the payment.
Here’s the specific language from IRS Pub 970:
If you are the person legally obligated to make interest payments and someone else makes a payment of interest on your behalf, you are treated as receiving the payments from the other person and, in turn, paying the interest.
So if, for example, your mom and dad pay some of your loans, you can still claim the interest for purposes of the deduction. But be careful: if your parent claims you as a dependent but you are legally obligated to pay the loan, then neither one of you can take the deduction.
To help you sort out the interest for purposes of the deduction, you should receive a tax form from your lender. Generally, if your lender received interest payments of $600 or more during the year, the lender is required to send you a form 1098-E by January 31. For more on the form 1098-E, click here.
