We all know getting higher education is EXTREMELY expensive! Because of this, most Americans have to take out student loans just to pay for their tuition and basic living expenses. After graduating with student loan debt, many taxpayers question what education expenses are tax deductible and if student loans can be written off.
A tax deduction for student loan interest paid is available to most U.S. taxpayers, including both itemized and standard deduction takers. However, student loan interest deductions have specific eligibility requirements that I’ll discuss later in this post. First, let’s talk about the different types of student loans.
Types of student loans
I realize most college students get a bad rap for ordering too much delivery pizza or taking on crippling credit card debt. However, many college students are living frugally and trying to make ends meet. Remember those days of scouring the campus for free food and begging your parents for gas money? Ah -- the good days.
During college, many students finance or supplement their experience with federal student loans. Students who don’t qualify for federal loans may decide to use a private student loan lender. Many potential borrowers choose to take out private loans because they don't want to put the financial burden on their parents from a Parent Plus Loan and can't get approved for the full cost themselves. Also, many students have to work a full time job to survive. Many federal loans require that students be enrolled at least half time towards a degree, certificate or other recognized credential, which can be hard while working full time. Private loans are useful to fill in the tuition gaps, but they come at a cost.
After college, you have the choice to refinance your federal student loans with a private lender. While refinancing may offer a better interest rate, you will lose all the federal student loan protections. These protections include different repayment plans based on your income levels and employment status.
Do both private and federal student loans qualify for the student loan interest deduction?
The short answer is YES, as long as your student loan is considered “qualified”. A qualified student loan means that you used your loan to pay for educational expenses for an academic period as an eligible student.
Moreover, you must have paid or incurred these qualified expenses within a reasonable amount of time before or after you’ve taken out the loan. Qualifying is the easy part because most lenders disburse the funds to align with the academic period.
Details of the IRS's tax deduction
The maximum amount the IRS allows you to deduct for student loan interest is $2,500 in a calendar year. This deduction is allowed regardless of if you are a standard deduction or itemized deduction taker. The meaning behind the jargon: No matter how you file your personal taxes, you are likely eligible.
What are the eligibility requirements?
The student loan interest deduction is subject to a few limitations. These won’t apply to most, but I will explain them below:
You cannot deduct loan interest when your MAGI (modified adjusted gross income before the student loan deduction) reaches $85,000 (single) or $170,000 (married filing jointly). Phase outs of the deduction start when your modified AGI is $70,000 for single filers or $140,000 (married filing jointly).
Spouses filing separately
You cannot deduct loan interest if your filing status is “Married Filing Separately”.
Loan from a relative
You cannot deduct loan interest on a loan taken from a relative.
Claimed as a dependent
You cannot deduct loan interest if you are claimed as a dependent on another person’s tax return. In addition, you can't claim someone as a dependent if they filed a joint return or had a total income of $4150 or more.
Claiming the tax deduction
One of the best tax benefits for education is the ability to lower your taxable income. The student loan interest deduction is calculated based on your income, tax bracket, and paid interest on student loans.
To claim this deduction, your first question is likely “How much student loan interest have I paid?”. Lucky for you, this is typically easy to figure out because loan servicers are required to send tax Form 1098-E (Student Loan Interest Statement) to any taxpayer who pays more than $600 to that lender in student loan interest during the year.
If you did not pay $600 in interest, you can simply login to your lender’s online portal and review your payment statements. From those statements, you will be able to calculate the paid interest. Remember to only deduct the interest payments, not the whole principle.
To claim the deduction, you will simply input the amount of interest paid during the tax year on Form 1040, Schedule 1. You’ll find a line called “Student Loan Interest Deduction” under the “Adjustments to Income” section.
However, any good tax preparation software will walk you through this deduction to make the process simple. Keeper’s filing software makes it easy to get all the deductions and tax credits you deserve, including student loan interest.
How much in taxes will this deduction save me?
The answer to this varies on your effective tax rate. However, with an effective tax rate of 15%, assuming the full $2,500 deduction, you will save about $375 in taxes, which is a nice tax break! This is especially true for freelancers and independent contractors who often have to pay instead of getting a tax refund.
Should I hold off on paying off my student loans in full so I can continue to get this deduction?
Great question. In short, no. The answer to this depends on your personal financial goals. However, the money you’ll save in interest by paying off your student loans early will outweigh the tax benefit received.
Many finance gurus make a case for investing in the market instead of paying on low interest debt. This is debatable in the personal finance world, so consider speaking to a professional for a more personalized answer to this question.
If I pay my child’s student loan, can I take the deduction on my own tax return?
Unfortunately, if you pay a student loan in your child’s name, you cannot take the tax deduction for the interest. The exception to this rule is if the loan is in your name and you are legally obligated to pay it.
Some parents may take out Parent PLUS federal student loans to pay for their child’s higher education expenses. The interest on these student loan payments is tax deductible for the parent because the loan is in their name.
The bottom line
Student loan interest is something that many students don’t consider before deciding to take on student debt. However, the cost of interest is something that should be weighed when determining the overall cost of taking on debt for education.
When it comes down to it, paying for your college education and living expenses using money you already have is the best option to save money. However, if student loans are inevitable, the student loan interest tax deduction can benefit you in the long run.
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