According to one recent report, the average total student debt is around $30,000. That’s about $5,000 more than students had to carry 10 years ago, representing a 20% increase in the borrowed amount.
If you borrowed money to help pay for college, then you could be eligible to deduct up to $2,500 from your taxes. Today, we’re sharing everything you need to know about this process, including how to understand important documents (like Form 1098) and how to get started.
What Is the Student Loan Tax Deduction?
Put simply, the student loan tax deduction is a tax break for college students and their parents. If you took out a student loan to help pay for your education, then you know that each type of loan has its own interest rate. This provision allows you to deduct up to $2,500 of that paid interest from your taxable income.
Pandemic-Related Changes to Interest Rates
In response to the ongoing COVID-19 pandemic, the U.S. Department of Education’s Federal Student Aid program paused loan payments and set interest rates to 0% for eligible federal student loans. This change became effective on March 13, 2020 and is still in affect through May 1, 2022.
However, even if you haven’t paid interest on your student loan since then, you could still receive this tax break if either of the following statements is true for you:
- You made payments toward an accrued or capitalized interest balance on your federal loan
- You made interest payments on loans that don’t qualify for this tax relief (e.g. private student loans)
The Basics Behind Deducting Student Loan Interest
Before we dive into the specific steps you need to take to claim this type of tax relief, let’s answer one basic question: How are student loan payments tax deductible?
The short answer is that not all payments are, so it’s important to know how and if you qualify. To assess your financial situation, the IRS will take a look at your modified adjusted gross income, or MAGI. If it’s less than $70,000, then you could be eligible to receive the full $2,500 deduction.
If it’s a little higher, you’re not completely out of luck. With a MAGI of $70,000 to $85,000, you could still receive a deduction, but it wouldn’t be as high as $2,500. The individual taxpayer cap is set at $85,000.
Note that if you’re filing jointly, those numbers are a little different. In that case, you could receive the full amount if your combined MAGI was less than $140,000. In addition, you could still receive a portion of the deduction if that amount rises as high as $170,000.
Note that there is no limit on the number of years that a student can deduct student loan interest. As long as your income stays within the above limits, you continue to pay on a qualified student loan, and you meet all other eligibility requirements, you can continue to take this deduction for as long as you need to.
Itemized Deductions vs. Above-the-Line Deductions
Both itemized deductions and above-the-line deductions can help reduce your taxable income. Yet, each one works a little differently.
Above-the-line deductions are adjustments made to your taxable income. In other words, they’re subtracted from your income before your adjusted gross income (AGI) is calculated. Conversely, itemized deductions (or below-the-line deductions) are reported literally below the line for AGI calculations on your tax return.
It’s important to note that the IRS considers a student loan interest deduction to be an above-the-line deduction. By subtracting it from your AGI, you lower your overall taxable income and save money.
Does My Student Loan Qualify?
Paying interest on student loan debt doesn’t automatically qualify you to receive a student loan tax deduction. Rather, there are a few different criteria you’ll need to meet to make sure your plan applies.
The first requirement is to meet the financial threshold. As defined above, you can’t make more than $85,000 (filing separately) or $170,000 (filing jointly). If you do meet this standard, then the IRS may allow you to deduct a portion of the interest you paid on your federal or private student loan.
Now, let’s take a look at a few of the other circumstances that could enable you to move forward in this process.
You Applied the Loan Toward Qualified Purchases
You must have used your student loan to pay for necessary and required expenses during your time at college. These include:
- Room and board
- Other course materials
This requirement is in place to make sure the IRS is only helping to fund academic pursuits that are legitimate and sound in nature. Your loan should have stipulations in place that govern how and when you can use the funds, and the same applies here.
You must have taken out the loan during an academic period for which you were enrolled at least half-time. The program you enrolled in must lead to a degree, certificate, or another type of recognized academic credential.
Did you apply some of your student loan funds toward a personal expense that doesn’t qualify per the list above?
If so, the deduction isn’t entirely lost. You’ll just need to adjust and reduce the amount that you claim accordingly. Make sure the amount you submit accurately reflects what you paid toward school expenses.
You Took Out the Loan to Further Your Own Education
When you think about paying off student loans, you might picture a graduate doing so once they’re out of school and out on their own. However, there are many students that want to get a head start on the process and start paying while they’re still in school.
Either way, your loan may qualify as long as you’ve continued to use the funds to pay for your personal education.
You Took Out the Loan to Further a Dependent’s Education
You can also take the student loan interest deduction if you applied for and took out a loan in your own name, but allowed a dependent to access and use the funds. For instance, Parent Plus Loans are federal loans that are made to the parent or legal guardian of an undergraduate student to help cover the cost of their education.
Note that if you’re a parent who helps a dependent pay back a student loan, you cannot claim the deduction.
You’re Obligated to Pay Back the Loan
You may be able to deduct any interest you’ve paid on your loan so far, even if you’re still paying on it. This applies even if you’ve defaulted on your student loan and the government is currently garnishing your paycheck to pay it back. Under the Debt Collection Improvement Act, federal agencies or collection agencies can garnish up to 15% of your disposable earnings to pay back defaulted debts.
There are two scenarios that would render you ineligible to claim the student loan interest deduction. These include:
- Your taxpayer filing status is Married Filing Separately
- You’re listed as a dependent on another taxpayer’s tax return
If you have any questions about your eligibility, then reach out to our experienced tax attorneys. Our team can assess your situation and help inform you about your options and next steps.
Understanding Form 1098
IRS Form 1098-E is your Student Loan Interest Statement. If you paid at least $600 in student loan interest during the qualifying tax year, then your student loan servicer will send you this form either by postal mail or email.
On it, you’ll find the exact amount that you paid in interest over the course of the tax year. You will enter this amount on your taxes to claim the deduction and lower your taxable income.
If, for some reason, you do not receive this form but you know that you meet all of the requirements, then you can also check your loan servicer’s website. There, the form should be available to download.
At this point, you may be wondering how you should proceed if your interest payments on a federal student loan have been frozen since March 2020. If you paid $0 in interest during the tax year, do you still qualify for this deduction?
The answer is yes, as long as you meet all other qualification requirements. You will still be able to deduct any amount that you did pay. You should be able to find all of these details in your online profile through the loan servicer’s website.
Can I Deduct My Student Loan Payment?
While we’re on the subject of taking deductions, let’s discuss why you’re only able to deduct the interest you paid on your loan, and not the actual payment itself.
As you pay down your student loan debt, you’re not only paying off the total amount that you took out to help fund your education. You’re paying that total plus the interest that the balance has accrued. While the interest is tax-deductible, the balance is not.
Are There Other Tax Breaks for Students?
While the student loan interest deduction can be a helpful tax break, it isn’t the only one available. If you’re still enrolled in an academic program and paying for your education, then you may qualify for additional tax credits and deductions.
- The American Opportunity Credit
- The Lifetime Learning Credit
You can learn more about how each program works on the IRS’ website.
The American Opportunity Credit allows students to claim up to $2,500 per year for their first four years of school. As long as you’re working toward a degree or similar credential, then you may be eligible. The Lifetime Learning Credit allows you to claim up to $2,000 per year for any college or career-related tuition and fees.
There is no cap on how long you can claim the Lifetime Learning Credit, and it can also apply toward other school-related expenses, such as:
- Tuition and fees
- School supplies
- School equipment
Even if you don’t qualify for either deduction listed above, you may still be able to claim the Tuition and Fees deduction, available through IRS Form 8917. As with the student loan interest deduction, married taxpayers will need to file as Married Filing Jointly in order to be eligible for the above tax breaks.
Navigating All of Your Options
Understanding all of your options, you may wonder which credits and tax breaks will save you the most money. Ultimately, it will depend on your income, repayment timeline, and a few other factors. Our qualified tax attorneys can consult you on all of your available options and help you feel confident that you’re making the right decision.
In most cases, a tax credit will be even more valuable than a deduction. This is because credit is subtracted from the tax you owe, following a dollar-for-dollar basis. Conversely, a deduction reduces your taxable income.
For example, if you had $35,000 in income but you claimed the full $2,500 student loan interest deduction, then you would only have to pay taxes on $32,500 in income.
At the end of the day, it’s always smart to weigh all of your options. You never want to pay more taxes than you need to, especially while you’re also trying to pay off the cost of your education. After you graduate, you’ll likely have other loans and expenses to cover, such as a mortgage or small business loan, so it’s smart to save where and when you can!
Maximize Your Education-Related Tax Savings
There are many different programs in place to help undergraduate and graduate students reduce their tax burden. The student loan interest deduction is one of them. If you qualify, then you will receive Form 1098 before it’s time to file your taxes.
By claiming these breaks and deductions, you can help make your education a little more affordable, and that’s always a smart move. While this guide can help you get started, we understand that you might still want to learn more about how these programs work.
Contact Silver Tax Group today to discuss all of your tax-related questions and needs.