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Updated on Friday, September 28, 2018
When you have student loan payments on top of all your other bills and financial responsibilities, every little bit of savings helps.
The student loan interest deduction won’t make you rich, and it won’t completely relieve the burden of your payments. But it could save you a few hundred dollars per year, so it’s worth understanding how it works and how you can take advantage of it.
What is the student loan interest deduction?
The student loan interest deduction allows you to subtract some of the interest you paid on your student loans during the year from your taxable income. By reducing your taxable income, the deduction saves you money by diminishing the amount of taxes you owe.
The IRS allows you to deduct up to $2,500 of interest paid per year on “qualified student loans,” which is any loan that was:
- Taken out for you, your spouse or a qualifying dependent
- Used to pay qualified higher education expenses for an eligible student
- Used within a reasonable time period after taking out the loan
According to Jason Speciner, CFP, enrolled agent and the founder of Financial Planning Fort Collins, the definition of “qualified student loan” is broader than you might think.
“Interest on loans that are specifically student loans obviously counts, but you’re allowed to take the student loan interest deduction for any debt as long as it meets certain standards,” said Speciner. “It has to be used only for education expenses [and] it has to be debt that isn’t otherwise deductible.”
As an example, Speciner says that a personal loan taken out within 90 days of receiving your tuition bill would count, as long as the loan is only used for education expenses. A home equity loan, however, typically wouldn’t be eligible since it is not strictly related to your education expenses.
Wendy Marsden, CPA, CFP and principal at ProsperiTea Planning, adds that private student loans are also eligible for the deduction and that you might be able to deduct the interest from your state tax as well.
“Many states have what are called ‘piggyback taxes’ that say that whatever your federal income is, that’s what they’ll use as your state income tax base,” said Marsden. “In that case, if it’s deductible at the federal level, then it’s deductible at the state level too.”
Marsden emphasized that it is only the interest portion of your student loan payment that’s deductible. Some of each payment goes toward the principal of your loan, and that portion isn’t deductible.
However, one of the big advantages of the student loan interest deduction, according to Speciner, is that it’s an above-the-line deduction, meaning that you don’t have to itemize deductions in order to claim it.
“That’s the beauty of this thing,” said Speciner. “If you look at the typical taxpayer who’s within the income range that’s allowed to claim the deduction, they’re typically not itemizing deductions. But here, they’re still allowed to take it.”
The bottom line is that if you’re repaying any debt taken out exclusively for education expenses, the student loan interest deduction can help ease the burden of those payments by reducing your tax bill.
Do you qualify for the student loan interest deduction?
The downside of the student loan interest deduction is that not everyone will qualify. There are several criteria you have to meet.
First, as explained above, the interest has to be paid on a “qualified student loan,” taken out for you, your spouse or a qualifying dependent.
Second, you must have personally paid the interest during the tax year in question, and you must be legally obligated to pay that interest. One of the implications here is that if you are a parent making payments on your child’s student loan and you aren’t a cosigner on it, you are not allowed to deduct those interest payments because you are not personally obligated to make them.
“For a personal example, I told my son that I would pay his student loans if he got [a grade point average of] over a 3.0,” said Marsden. “He did that, so now those loans are in his name, but I am paying them, and I can’t take the deduction even though I’m paying the interest.”
You also can’t claim the deduction if you are married but file taxes separately. You must either be a single filer or file jointly as a married couple, and you must not be claimed as a dependent on anyone else’s tax return.
Finally, the deduction is phased out once your income reaches a certain point. For single filers, the phaseout begins when your Modified Adjusted Gross Income (MAGI) reaches $65,000, and the deduction is eliminated completely once your MAGI reaches $80,000. For married couples filing jointly, the phaseout runs from $135,000 to $165,000.
“It’s almost always income that keeps people from being able to claim the deduction,” said Speciner. “I have clients come in with $5,000 of interest paid during the year, and I have to tell them they can’t deduct it because their income is too high.”
On the other hand, Marsden points out that there are a few sweet spots where the deduction can be incredibly valuable.
“Teachers are a really good example of people who can benefit from the student loan interest deduction,” she said. “Anybody with a medium- to low-earning career, or anyone who is early in their career, can benefit from it.”
How to calculate your student loan interest deduction
In a moment, you’ll learn how to report the exact right amount of student loan interest you paid for tax purposes, but first you might want to know ahead of time how much you stand to save.
Here’s a process that will help you estimate the value of your student loan interest deduction:
- First, make sure you’re not above the income limits. For single filers, that’s a MAGI of $80,000, and for joint filers, it’s a MAGI of $165,000. Click here for an overview of how to estimate your MAGI. If you are over those limits, you won’t be able to claim the deduction.
- For each individual student loan, multiply your current balance by your interest rate to get the approximate amount of interest you’ll pay during the year. For example, if you have a $10,000 loan with a 6.8% interest rate, you can multiply them together to get an estimated annual interest payment of $680.
- Add together the estimated interest for each loan to get the total amount of interest you expect to pay across all your student loans.
- Cap that number at $2,500.
- If you’re single and your MAGI is between $65,000 and $80,000, or if you’re married and your MAGI is between $135,000 and $165,000, you’ll have to calculate your phaseout. To do that, first subtract the bottom MAGI limit ($65,000 for singles, $135,000 for couples) from your estimated MAGI, then divide that result by either $15,000 if you’re single or $30,000 if you’re married filing jointly. Here’s an example:
- You’re married, filing jointly and your estimated MAGI is $150,000.
- Subtract $135,000 (the bottom MAGI limit) from $150,000 to get $15,000.
- Divide $15,000 by $30,000 (single filers would divide by $15,000).
- That result is 0.5.
- Multiply 0.5 by the total interest you calculated in Steps 3 and 4 to determine the final amount you’ll be able to deduct.
- Multiply the amount of interest you’re able to deduct by your federal tax rate to get your estimated savings. For example, if you are in the 22% tax bracket and you can deduct $2,500 in student loan interest, you stand to save $550 at tax time. If you’re not sure what your tax rate is, you can use this tool from TurboTax.
- If the interest is deductible for state income tax purposes as well, you can multiply your state tax rate by the amount of your eligible interest to calculate your additional savings.
However, there are a few other factors to consider.
According to the IRS, the interest is only deductible to the extent that the loan was used to pay qualified education expenses, and those expenses are reduced by other money that was received tax-free for that same purpose, including:
- Employer-provided education assistance
- Tax-free distributions from a 529 plan or Coverdell ESA
- Savings bond interest used for education
- Scholarships and grants
- Veterans’ educational assistance
- Other tax-free payments used for education, aside from gifts or inheritances
In other words, if you used any of those sources to pay for education expenses, and you think that as a result, your entire student loan balance may not have gone toward qualified education expenses, you may want to consult with a CPA before deducting all of your student loan interest.
On the other hand, the IRS does allow you to count a few additional expenses as interest for the purpose of the student loan interest deduction:
- Loan origination fees
- Capitalized interest, which is interest that has been added to the principal of the loan
- Interest on credit card debt, as long as that debt was used solely to pay for qualified education expenses
- Interest on refinanced and consolidated student loans
Steps to claiming your student loan interest deduction
For the most part, claiming your student loan interest deduction is fairly simple. The biggest potential hang-up is simply figuring out exactly how much interest you paid.
In general, any lender that received $600 or more in interest payments from you during the year must send you a Form 1098-E, which will specify exactly how much interest you paid. However, that form might not include things like loan origination fees or capitalized interest, which would also be eligible for the deduction.
You may not always receive a Form 1098-E, either because you didn’t pay at least $600 in interest or because your lender didn’t mail it out, in which case you may need to do some digging.
“The lender is going to have a statement or a website where you can see how much interest you paid during the year, as well as other relevant information,” said Speciner. “And if you used another type of debt, like a personal loan, you won’t get a Form 1098-E, and you’ll definitely have to use the lender’s records at that point.”
Once you have that information, Speciner says it’s simply a matter of providing it to your tax professional or entering it into the tax preparation software you’re using. Your allowed deduction will be calculated and added to your return.
If you’d like to fill out your tax return on your own without the help of a professional or software, IRS Publication 970 has detailed guidance on both calculating and reporting your deduction.
Taking full advantage of the student loan interest deduction
The student loan interest deduction doesn’t completely relieve the burden of making payments, and it doesn’t eliminate the cost of your loans. But it’s a helpful way to save a little bit of money if you’re able to claim it, and as Marsden points out, the best way to take advantage is to simply be aware that it exists.
“The hardest part is not knowing that it’s there,” she said. “So just knowing that there’s a deduction, you can find the other information you need to find.”
In most cases, all you need to do at tax time is get an accurate record of the amount of student loan interest you paid during the year on each eligible loan and make sure you report it either to your professional tax preparer or into your tax-prep software. Doing so will allow you to take full advantage of the student loan interest deduction.