How to Deduct Student Loan Interest on Your Taxes
February 12, 2015

Many people refer to the weeks leading up to April 15 as tax season. However, unlike the holiday season, this season does not necessarily bring good tidings of great joy. Rather, it could leave you struggling with several documents and papers, as you make haste to figure out the tax code, to complete and file your tax returns with the Internal Revenue Service (IRS) before the deadline of April 15.

Unfortunately, not many people have the ability to make sense of the complexities of the tax code. Therefore, ascertaining the tax burdens and benefits that apply specifically to your personal situation could be difficult. As a result, computing the amount of tax you need to pay could become an intimidating activity.

Tax Deduction on Student Loan Interest Paid During the Tax Year

The IRS has enabled homeowners to claim deductions on the mortgage interest they pay for their homes. However, since 1998, the IRS has also allowed taxpayers, who are repaying their student loans, to claim a tax deduction. It enables these individuals to deduct the interest on student loans that they have paid during the tax year.

However, the maximum deduction the IRS provides is $2,500. Therefore, you will only receive $2,500, even if you paid a higher amount of student loan interest. Moreover, you can capitalize on this deduction without having to itemize it. The IRS treats this deduction as an adjustment to the income you report for tax purposes.

Are You Eligible for Claiming the Student Loan Interest Deduction?

To be eligible for claiming this deduction, you will need to meet certain criteria. You can claim the student loan interest deduction if:

  • You file your tax return with one of the following filing statuses:
    • Single
    • Married or,
    • Married, filing jointly
  • No one else is claiming an exemption for you on their tax returns
  • The student is either you, your spouse or your dependent
  • You used the student loan to pay qualified education expenses, such as tuition, fees, room and board, books, equipment and necessary travel
  • You have borne the qualified education expenses within a reasonable period before or after taking out the student loan via a federal post-secondary education loan program
  • Your Modified Adjusted Gross Income (MAGI) is below the upper threshold specified by the IRS:
    • If your filing status is single, head of household or qualifying widow(er) – $65,000 to $80,000
    • If your filing status is ‘Married, filing jointly’ – $130,000 to $160,000
  • You are enrolled at least half-time in a degree program in an eligible educational institution i.e. a college, a university, a vocational school, or another post-secondary educational institution eligible for participation in a student aid program administered by the US Department of Education
  • You have not obtained the student loan from someone related to you (e.g. a grandparent, parent or spouse) or through a qualified employer plan

What is the Modified Adjusted Gross Income (MAGI)?

The MAGI denotes the sum of:

  • Your Adjusted Gross Income (AGI)
  • Your student loan deductions
  • Your higher education deductions
  • Your foreign income and foreign housing deductions and,
  • Your IRA contribution deductions
Filing Status Phase-out Begins Phase-out Ends
Single $65,000 $80,000
Head of Household $65,000 $80,000
Qualifying Widow (er) $65,000 $80,000
Married, Filing Jointly $130,000 $160,000
Married, Filing Separately NA NA

If your MAGI is below the threshold where the phase-out begins, you can deduct up to $2,500 in student loan interest. Similarly, if your MAGI is over the threshold where the phase-out ends, you are ineligible for the student loan interest deduction.

However, if your MAGI falls within the phase-out range, you will receive a prorated student loan interest deduction. To arrive at this amount:

  • Calculate the fraction where:
    • The numerator will be your MAGI minus the threshold amount where the phase-out begins (depending on your filing status)
    • The denominator will be $15,000 (for a single filing status) [or $30,000 for a joint filing status)
  • Multiply the interest paid on a student loan with the result of the above fraction
  • Subtract the result from the interest paid on the student loan during the tax year
  • This result will be the amount that you can claim as student loan interest deduction

Example: Your MAGI is $150,000 and you are filing a joint return. You paid $900 interest on a qualified student loan. Using the steps listed above:

  • The fraction is:
    • The numerator is $150,000 – $130,000 = $20,000
    • The denominator is $30,000
    • Therefore, the fraction amounts to 0.67
  • Multiply the result of the fraction with the interest paid on the student loan i.e. 0.67 x $900 = $600
  • Subtract the result arrived at above from the interest paid on the student loan i.e. $900 – $600 – $300
  • You can claim a student loan interest deduction of $300 in your tax return

Inclusions and Exclusions Governing the Student Loan Interest Deduction

It is worth noting that you cannot claim this deduction if you used tax-free funds e.g. veterans’ education assistance for paying qualified education expenses. Therefore, you will need to reduce your qualified education expenses by the total amount paid for:

  • Employer-provided educational assistance
  • Tax-free distribution of earnings from a Coverdell education savings account or a Qualified Tuition Program (QTP)
  • US savings bond interest (previously excluded from income)
  • Tax-free scholarships, fellowships and grants and,
  • Veterans’ benefits

In addition, if you file your tax return with the filing status as ‘Married, filing separately,’ you will not be able to claim this deduction.

However, some students open revolving lines of credit i.e. credit cards to pay for qualified education expenses only. These students can claim a deduction based on the interest levied on these revolving lines of credit.

Who Can Claim Student Loan Interest Deduction – the Parent or the Student?

In most cases, the individual whose name the lender lists on the loan has the legal obligation for making interest payments on the loan. As a result, this individual typically gets to deduct the student loan interest.

Therefore, many students will have the legal obligation to pay the interest on their student loans. However, if their parents pay this on their behalf, the IRS treats it as if the student paid the interest. As a result, these students can claim loan payments made by other people on the students’ behalf as deduction.

According to the IRS, you will not be able to capitalize on this deduction, if other people list you as a dependent on their tax returns. In addition, neither you nor the dependent student can claim the deduction if the dependent has the legal obligation for repaying the student loan

How Can You Ascertain the Amount of Interest You Have Paid Toward Your Student Loan?

Students typically send their loan payments to the bank or another lending institution. As the tax season approaches, many lenders send the 1098-E form to their student loan borrowers. The amount paid as student loan interest appears in the box with the heading ‘1 Student loan interest received by lender.

However, some students might not receive this form from their lenders. This is because their interest payments might not be large enough to warrant that the lender send them the 1098-E form. These students would need to calculate their interest payments based on their loan statements.

Students will need to review their 1098-E forms to ensure that the amount filled in is accurate. This is because at times, the form might not list the correct amount paid by the student toward interest, as certain other expenses could come under the purview of deductible interest.

For example, if you took out a student loan prior to September 2004, the lender can omit mentioning the loan origination fee on the 1098-E form. If the lender did not use this fee toward property or services, it could qualify as interest. In this scenario, students would need to figure out how much they paid toward the origination fee in a specific tax year, by using a “reasonable method.”

Are There Any Other Costs that Could Constitute Deductible Interest?

Certain other costs or expenses might also qualify for treatment as deductible interest. These include:

  • Capitalized Interest: This denotes interest that students have not paid yet, that lenders typically add to the principal of the loan payment
  • Voluntary Interest Payments: These comprise any loan payments made before they become due
  • Refinanced Student Loan Interest: These comprise collapsed or consolidated student loans, as long as students utilize the funds toward qualified education expenses

For How Long Can Students Claim the Student Loan Interest Deduction?

Students could claim the deduction for student loan interest for the remaining period of the loan. However, they would need to ensure that they used the loan for paying for qualified education expenses. In addition, they would need to ensure that these expenses occurred within a reasonable period before or after they took out the student loan.

Some Common Mistakes to Avoid When Claiming Education Credits

Before submitting the tax return, ensure that it does not have the following errors:

  • The individual claiming the deduction appears as a dependent or a spouse on another tax return
  • The individual claiming the deduction does not have a 1098-T form showing that they attended an eligible educational institution
  • The individual claiming the deduction did not pay for the qualifying education expenses
  • The individual claiming the deduction is a student who was not attending a college or any other higher education institution

If the concepts of AGI and MAGI still confuse you, consider clicking here to figure out the difference. To obtain more information on the tax benefits provided by the IRS for education, click here.