How to Get the Most from Tax Deductions for Student Loan Interest

October 9, 2013

Did you know you can deduct up to $2,500 per year in student loan interest from your taxes? If you are paying back student loans and not taking this deduction, you are giving money away! If you’re single you should definitely be taking advantage of the student loan tax deduction. If you have student loans you’ve taken for a dependent, you may be able to take advantage of this deduction. If you are married, though, there are a couple of considerations you should be aware of that we will review in today’s blog. Here’s what you need to know for each of these circumstances.

Form 1098-E

Each year, your lender should provide you with a Form 1098-E that confirms how much in interest you paid for the prior tax year. If your lender doesn’t provide you with the form by January 31st each year, contact them to request a copy. If you pay less than $600 in interest in a given year, your lender may not issue you the form but you can still take the deduction. The maximum you can deduct each year is $2,500. Early on in your repayment cycle, more of what you pay is interest. Student loans of roughly $37,000 at 6.8% will trigger this amount of interest annually.

If You’re Single and Deducting Interest on Your Own Loans

If you earn less than $60,000 you can take the maximum deduction. If you earn between $60,000-$75,000 you can take a prorated amount. What’s nice about this deduction is that you don’t have to itemize deductions to take it. It is actually an adjustment to income. On Form 1040 line 33 you list your eligible student loan interest. This then lowers your adjusted gross income which will lower the amount of your taxes assessed. Although not as good as a tax credit that lowers your taxes dollar per dollar, it’s better than nothing…

If You’re a Parent Dealing with Your Children’s Student Loans

This subject is a little trickier if you’re a parent. If you have taken out parent PLUS loans or other loans to pay for your dependent’s education you can take a deduction for the interest you pay subject to the earnings limits. If you’re single and earning $60,000 or less you can take the maximum. For marrieds, less than $125,000 in earnings gets you the full deduction. Earning above $75,000 in income for single parents and $155,000 in income for married parents means you can’t take the deduction. Between these two ranges will get you a prorated amount. If you are paying loans on your dependent’s behalf (that are issued in their name) then neither of you can take the interest deduction!

Student loan interest deduction

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If You’re Married and Relying on an Income Driven Repayment Plan

If you’re enrolled in Income Based Repayment (IBR) or Pay As You Earn (PAYE), your adjusted gross income determines how much your payments will be. If you file with your status as married filing jointly, both incomes will count toward your IBR or PAYE threshold. This can result in higher payments or denial to enroll. If you file married filing separate, your income for IBR/PAYE will be lower and your calculated payments lower but you won’t be able to take the interest deduction. This is where it gets more complicated.

If you are cash strapped, the lower monthly payment is likely more important. If you have a marginal tax rate of 20%, then the $2,500 reduction in income translates to less than $500 in savings. But if you earn $35,000 and your spouse $40,000 and you have $35,000 in loans, filing taxes together disqualifies you for IBR. If you file married filing separate, you would qualify for payment reduction from $400 down to roughly $220. Obviously, it’s better to pay down your debts as soon as you can, but if you simply can’t afford the standard plan, applying for IBR or PAYE will save you more than the tax deduction.

Get the Information You Need

In addition to understanding what your options are for deducting student loan interest deductions, you should also have a clear picture of your total debt and what your options are. Tuition.io can help with that. Sign up for our free student loan tool to get a snapshot of your debt at any moment in time, track your progress, payments and explore a customized plan to optimize your debt. Check out our blog for great articles and our student loan help center for a roster of helpful information.