What is the student loan interest deduction?
The term student loan interest deduction refers to a federal tax deduction that allows borrowers to subtract up to $ 2,500 of interest paid on qualifying student loans from their taxable income. This is one of the many tax breaks available to students and their parents to help pay for their higher education. Individuals must meet certain eligibility criteria, including filing status and income level, in order to qualify for the deduction.
Key points to remember
- The interest deduction on student loans allows borrowers to deduct up to $ 2,500 from the interest paid on a higher education loan directly on the Form 1040.
- Eligibility for the deduction includes an individual’s filing status and income level.
- The deduction is capped at the amount paid for those who paid less than $ 2,500.
- Anyone who pays more than $ 600 in interest for the year must receive a Form 1098-E from the lending institution.
- Federal student loan borrowers may not have any deductions to claim because interest payments on these student loans have been suspended by President Joe Biden until January 31, 2022.
How the interest deduction on student loans works
The Internal Revenue Service (IRS) describes a variety of tax deductions that allow individuals to reduce their taxable income for the year. One of them is the student loan interest deduction, which deducts up to $ 2,500 from interest paid on a student loan in the tax year. For example, individuals in the 22% tax bracket and claiming a deduction of $ 2,500 can reduce their federal income tax for the year by $ 550.
Taxpayers who wish to use the deduction must meet certain conditions. For example:
- The student loan must have been taken out for the taxpayer, his or her spouse or dependents. Parents who help legal borrowers repay cannot claim the deduction.
- The loan must be taken out during an academic period for which the student is enrolled at least half-time in a program leading to a diploma, certificate or other recognized title.
- The loan must be used for eligible higher education expenses (tuition, fees, textbooks, supplies and equipment) and cannot include room and board, student health costs, insurance and transport.
- The loan must be used within a “reasonable time” after its subscription, and the proceeds must be paid either within 90 days before the start of the academic period or 90 days after its end.
- The school where the student is enrolled must be an eligible institution, including all accredited public, nonprofit, and private for-profit post-secondary institutions that participate in student aid programs administered by the U.S. Department of Education. Education.
Unlike most other deductions, the student loan interest deduction is claimed as an income adjustment on Form 1040. This means that you do not have to complete a Schedule A, which is used to itemize deductions, in order to claim it.
As noted, you can deduct up to $ 2,500 from the interest you paid on a qualifying student loan. If you paid less than that, your deduction is capped at the amount you paid. If you paid more than $ 600 in interest for the year, you should receive a Form 1098-E from the lending institution. If you don’t receive it, you can download it directly from the IRS website.
Income limits for eligibility
The interest deduction on student loans is reduced or eliminated entirely for high income taxpayers. For the 2020 tax year, the amount of your student loan interest deduction is gradually reduced or eliminated if your modified adjusted gross income (RMAG) is between $ 70,000 and $ 85,000 ($ 140,000 and $ 170). $ 000 if you are filing a joint return). You cannot claim the deduction if your MAGI is $ 85,000 or more ($ 170,000 or more if you are filing a joint return).
Remember that these numbers only apply to the 2020 tax year, they are adjusted annually for inflation.
Student Loan Interest Deduction Versus Other Breaks
Students enrolled in higher education programs and their parents may be eligible for other reliefs, including tax credits, in addition to the interest deduction on student loans. Tax credits are even more valuable than deductions because they are subtracted from the tax you owe on a dollar-for-dollar basis rather than just reducing your taxable income.
U.S. Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit (AOTC) allows taxpayers to receive a credit for qualifying expenses paid for an eligible student’s graduate education during their first four years at a post-secondary institution. Total credit is capped at $ 2,500 per student per year. Taxpayers receive 100% of the credit for the first $ 2,000 spent on expenses and 25% for the next $ 2,000 spent on that student.
Lifetime Learning Credit (LLC)
The Lifetime Learning Credit (LLC) provides students with a tax credit of up to $ 2,000 per tax return for eligible tuition and educational expenses that are enrolled at an eligible post-secondary institution. This includes all eligible expenses used to pay for undergraduate, graduate and professional degree courses. There is no cap on the number of years that taxpayers can apply for the credit.
Taxpayers must meet three criteria to apply for the credit:
- The taxpayer, his or her dependent or another party pays the qualified higher education expenses.
- The taxpayer, their dependent or another party pays the expenses of an eligible student enrolled in an eligible institution.
- The taxpayer is the student, their spouse or a dependent listed on their income tax return.
Education savings plans
You can also get tax benefits by participating in a 529 plan. This type of savings plan offers tax benefits to parents who save for their children’s education. The Tax Cuts and Jobs Act (TCJA) of 2017 expanded the rules to include paying up to $ 10,000 in annual tuition fees for K-12 programs in private, public, and religious schools.
The rules were further expanded when the Setting Every Community Up for Retirement Enhancement (SECURE) law was passed in December 2019. This law allows account holders to use their plans to pay for costs associated with the approved learning program. ‘a beneficiary and withdraw a lifetime maximum of $ 10,000 to be applied to qualifying student debt.
Student loan payment suspensions
On March 13, 2020, President Trump indefinitely suspended payments on federal student loans, without interest, during the coronavirus crisis. Then, on his first day in office, Jan. 20, 2021, President Joe Biden maintained the break until Sept. 30, 2021. The US Department of Education extended that deadline to Jan. 31, 2022, in order to provide borrowers with a transition to repayment.
Keep in mind, however, that this does not affect private student loans, but it will mean that you may not have any interest payments to deduct for federal student loans while this suspension is in effect. .
As part of the US bailout, promulgated on March 11, 2021 by President Biden, all forms of student loan cancellations from January 1, 2021 through the end of 2025 are now tax exempt.
Example of interest deduction on a student loan
Here is a hypothetical example to show how interest deductions on student loans work. Suppose you are a single taxpayer with a MAGI of $ 72,000 who paid $ 900 in interest on a student loan. Because you have earned too much money to qualify for a full deduction, you need to calculate your partial deduction. The first part of the calculation would be:
$900 × $80,000 – $65,000$72.000 – $65,000 = $900 × $15,000$7,000 = $420
The $ 420 represents how much of your $ 900 interest is denied. So as a final step, you subtract $ 420 from $ 900 to arrive at an allowable deduction of $ 480.
IRS Publication 970: “Educational Tax Benefits” includes a worksheet that you can use to calculate your adjusted adjusted gross income and the interest deduction on student loans.