Definition of the interest deduction for student loans
What is the Interest Deduction for Student Loans?
The term Student Loan Interest Deduction refers to a federal income tax deduction that allows borrowers to deduct up to $ 2,500 of the interest on qualifying student loans from their taxable income. It is one of several tax breaks available to students and their parents to help fund higher education. Individuals must meet certain eligibility criteria, including enrollment status and income level, to qualify for the deduction.
The central theses
- The Student Loan Interest Deduction allows borrowers to deduct up to $ 2,500 of the interest paid on a college education loan directly on Form 1040.
- Eligibility to deduct includes a person’s registration status and income level.
- The deduction is limited to the amount paid for those who paid less than $ 2,500.
- Anyone paying more than $ 600 in interest for the year should obtain a Form 1098-E from the financial institution.
- Federal student loan borrowers may not be able to claim any deductions as interest payments on these student loans have been suspended by President Joe Biden until January 31, 2022.
This is how the interest deduction for student loans works
The Internal Revenue Service (IRS) outlines a variety of tax deductions that allow individuals to reduce their taxable income for the year. One of these is the Student Loan Interest Deduction, which allows for up to $ 2,500 to be deducted from the interest paid on a student loan during the tax year. Individuals falling into the 22% tax bracket and claiming a $ 2,500 deduction can lower their federal income tax by $ 550 for the year.
Taxpayers who wish to claim the deduction must meet certain requirements. For example:
- The student loan must have been taken out for the taxpayer, the taxpayer’s spouse or dependents. Parents helping legal borrowers with repayment will not be able to claim the deduction.
- The loan must be taken out during a period of study for which the student is at least half enrolled in a degree program that leads to a degree, a certificate or another recognized certificate.
- The loan must be used for qualified college expenses (tuition, fees, textbooks, materials, and equipment) and must not include room and board, student health costs, insurance, and transportation.
- The loan must be used within a “reasonable period” of admission and the proceeds paid out either within 90 days before the start of the course or 90 days after the end of the course.
- The school the student is enrolled in must be an eligible institution, including all accredited public, not-for-profit, and private for-profit post-secondary institutions participating in student aid programs administered by the Department of Education.
Unlike most other deductions, the student loan interest deduction is claimed as an income adjustment on Form 1040. This means you don’t have to fill out Appendix A, which is used to break down deductions in order to claim.
As mentioned earlier, you can deduct up to $ 2,500 from the interest you paid on an eligible student loan. If you paid less, your deduction is limited to the amount you paid. If you paid more than $ 600 in interest for the year, you should obtain a Form 1098-E from the financial institution. If you don’t get it, you can download it directly from the IRS website.
Income limits for eligibility
For taxpayers with higher incomes, the interest deduction for student loans is reduced or canceled entirely. For the 2020 tax year, the interest deduction on your student loan will be gradually reduced or phased out if your Modified Adjusted Gross Income (MAGI) is between $ 70,000 and $ 85,000 ($ 140,000 and $ 170,000 if you file a joint statement). You will not be able to claim the deduction if your MAGI is $ 85,000 or more ($ 170,000 or more if you file a joint statement).
Remember that these numbers are only valid for the 2020 tax year. They are adjusted for inflation annually.
Interest deduction for student loans compared to other interruptions
Students enrolled in higher education programs and their parents may be eligible for other perks, including tax breaks, in addition to the deduction of interest on the student loan. Tax credits are even more valuable than deductions because they are deducted from the tax you owe on a dollar-for-dollar basis rather than simply reducing your taxable income.
American Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit (AOTC) enables taxpayers to credit qualifying expenses incurred in an eligible student’s higher education during their first four years at a post-secondary institution. Total credit is capped at $ 2,500 per student per year. Taxpayers will receive 100% of the credit on the first $ 2,000 spent on expenses and 25% on the next $ 2,000 spent on that student.
Lifelong Learning (LLC)
Lifetime Learning Credit (LLC) offers students a maximum tax credit of $ 2,000 per tax return for qualifying tuition and school-related expenses enrolled at an eligible post-secondary institution. This includes all qualifying expenses used to pay for bachelor, master and degree programs. There is no limit to the number of years taxpayers can avail of the credit.
There are three criteria that taxpayers must meet in order to be eligible for the credit:
- The taxpayer, his or her relative, or some other party pays for qualified higher education costs.
- The taxpayer, his or her relative or other party pays the cost of an eligible student enrolled in a qualifying institution.
- The taxpayer is the student, his / her spouse or a relative who is listed on his / her tax return.
College savings plans
You can also get tax breaks by joining a 529 plan. This type of savings plan offers parents tax advantages as they save for their children’s education. The Tax Cuts and Jobs Act (TCJA) of 2017 expanded the rules to include the payment of up to $ 10,000 in annual tuition fees for K-12 programs in private, public, and religious schools.
The rules were expanded even further when the Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed in December 2019. This law allows account holders to use their plans to pay costs related to a beneficiary’s approved education program and to withdraw for a lifetime of up to $ 10,000 on qualified student debt.
Student Loan Payment Suspensions
On March 13, 2020, President Trump indefinitely suspended interest-free payments on federal student loans during the coronavirus crisis. Then, on his first day in office, January 20, 2021, President Joe Biden continued the hiatus through September 30, 2021. The US Department of Education extended this deadline to January 31, 2022 to give borrowers a seamless transition into repayment.
Note, however, that this has no impact on personal student loans, but it does mean you may not need to deduct federal student loan interest payments while this suspension is in effect.
As part of the American bailout plan that went into effect on March 11, 2021 by President Biden, all forms of student loan issuance from January 1, 2021 through the end of 2025 are now tax-free.
Example of an interest deduction for a student loan
Here is a hypothetical example to show how the student loan interest deduction works. Let’s say you are a single taxpayer with a MAGI of $ 72,000 who paid $ 900 in interest on a student loan. Since you earned too much to be eligible for a full deduction, you will need to calculate your partial deduction. The first part of the calculation would be:
$900 × $8th0,000 – $6th5,000$7th2.000 – $6th5,000 = $900 × $15,000$7th,000 = $4th20
The $ 420 represents how much of your $ 900 in interest is not allowed. So the final step is to subtract $ 420 from $ 900 to get an allowable deduction of $ 480.
IRS Publication 970: “Education Tax Benefits” provides a worksheet you can use to calculate your gross modified adjusted income and student loan interest deduction.