When you have student loan payments on top of all your other bills and financial responsibilities, every little bit of savings helps.
The student loan interest deduction wonât make you rich, and it wonât completely relieve the burden of your payments. But it could save you a few hundred dollars per year, so itâs worth understanding how it works and how you can take advantage of it.
The student loan interest deduction allows you to subtract some of the interest you paid on your student loans during the year from your taxable income. By reducing your taxable income, the deduction saves you money by diminishing the amount of taxes you owe.
The IRS allows you to deduct up to $2,500 of interest paid per year on âqualified student loans,â which is any loan that was:
According to Jason Speciner, CFP, enrolled agent and the founder of Financial Planning Fort Collins, the definition of âqualified student loanâ is broader than you might think.
âInterest on loans that are specifically student loans obviously counts, but youâre allowed to take the student loan interest deduction for any debt as long as it meets certain standards,â said Speciner. âIt has to be used only for education expenses [and] it has to be debt that isnât otherwise deductible.â
As an example, Speciner says that a personal loan taken out within 90 days of receiving your tuition bill would count, as long as the loan is only used for education expenses. A home equity loan, however, typically wouldnât be eligible since it is not strictly related to your education expenses.
Wendy Marsden, CPA, CFP and principal at ProsperiTea Planning, adds that private student loans are also eligible for the deduction and that you might be able to deduct the interest from your state tax as well.
âMany states have what are called âpiggyback taxesâ that say that whatever your federal income is, thatâs what theyâll use as your state income tax base,â said Marsden. âIn that case, if itâs deductible at the federal level, then itâs deductible at the state level too.â
Marsden emphasized that it is only the interest portion of your student loan payment thatâs deductible. Some of each payment goes toward the principal of your loan, and that portion isnât deductible.
However, one of the big advantages of the student loan interest deduction, according to Speciner, is that itâs an above-the-line deduction, meaning that you donât have to itemize deductions in order to claim it.
âThatâs the beauty of this thing,â said Speciner. âIf you look at the typical taxpayer whoâs within the income range thatâs allowed to claim the deduction, theyâre typically not itemizing deductions. But here, theyâre still allowed to take it.â
The bottom line is that if youâre repaying any debt taken out exclusively for education expenses, the student loan interest deduction can help ease the burden of those payments by reducing your tax bill.
The downside of the student loan interest deduction is that not everyone will qualify. There are several criteria you have to meet.
First, as explained above, the interest has to be paid on a âqualified student loan,â taken out for you, your spouse or a qualifying dependent.
Second, you must have personally paid the interest during the tax year in question, and you must be legally obligated to pay that interest. One of the implications here is that if you are a parent making payments on your childâs student loan and you arenât a cosigner on it, you are not allowed to deduct those interest payments because you are not personally obligated to make them.
âFor a personal example, I told my son that I would pay his student loans if he got [a grade point average of] over a 3.0,â said Marsden. âHe did that, so now those loans are in his name, but I am paying them, and I canât take the deduction even though Iâm paying the interest.â
You also canât claim the deduction if you are married but file taxes separately. You must either be a single filer or file jointly as a married couple, and you must not be claimed as a dependent on anyone elseâs tax return.
Finally, the deduction is phased out once your income reaches a certain point. For single filers, the phaseout begins when your Modified Adjusted Gross Income (MAGI) reaches $65,000, and the deduction is eliminated completely once your MAGI reaches $80,000. For married couples filing jointly, the phaseout runs from $135,000 to $165,000.
âItâs almost always income that keeps people from being able to claim the deduction,â said Speciner. âI have clients come in with $5,000 of interest paid during the year, and I have to tell them they canât deduct it because their income is too high.â
On the other hand, Marsden points out that there are a few sweet spots where the deduction can be incredibly valuable.
âTeachers are a really good example of people who can benefit from the student loan interest deduction,â she said. âAnybody with a medium- to low-earning career, or anyone who is early in their career, can benefit from it.â
In a moment, youâll learn how to report the exact right amount of student loan interest you paid for tax purposes, but first you might want to know ahead of time how much you stand to save.
Hereâs a process that will help you estimate the value of your student loan interest deduction:
However, there are a few other factors to consider.
According to the IRS, the interest is only deductible to the extent that the loan was used to pay qualified education expenses, and those expenses are reduced by other money that was received tax-free for that same purpose, including:
In other words, if you used any of those sources to pay for education expenses, and you think that as a result, your entire student loan balance may not have gone toward qualified education expenses, you may want to consult with a CPA before deducting all of your student loan interest.
On the other hand, the IRS does allow you to count a few additional expenses as interest for the purpose of the student loan interest deduction:
For the most part, claiming your student loan interest deduction is fairly simple. The biggest potential hang-up is simply figuring out exactly how much interest you paid.
In general, any lender that received $600 or more in interest payments from you during the year must send you a Form 1098-E, which will specify exactly how much interest you paid. However, that form might not include things like loan origination fees or capitalized interest, which would also be eligible for the deduction.
You may not always receive a Form 1098-E, either because you didnât pay at least $600 in interest or because your lender didnât mail it out, in which case you may need to do some digging.
âThe lender is going to have a statement or a website where you can see how much interest you paid during the year, as well as other relevant information,â said Speciner. âAnd if you used another type of debt, like a personal loan, you wonât get a Form 1098-E, and youâll definitely have to use the lenderâs records at that point.â
Once you have that information, Speciner says itâs simply a matter of providing it to your tax professional or entering it into the tax preparation software youâre using. Your allowed deduction will be calculated and added to your return.
If youâd like to fill out your tax return on your own without the help of a professional or software, IRS Publication 970 has detailed guidance on both calculating and reporting your deduction.
The student loan interest deduction doesnât completely relieve the burden of making payments, and it doesnât eliminate the cost of your loans. But itâs a helpful way to save a little bit of money if youâre able to claim it, and as Marsden points out, the best way to take advantage is to simply be aware that it exists.
âThe hardest part is not knowing that itâs there,â she said. âSo just knowing that thereâs a deduction, you can find the other information you need to find.â
In most cases, all you need to do at tax time is get an accurate record of the amount of student loan interest you paid during the year on each eligible loan and make sure you report it either to your professional tax preparer or into your tax-prep software. Doing so will allow you to take full advantage of the student loan interest deduction.
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