With the high cost of higher education, the government understands most students will take out a loan to help finance their investment. To help ease some of the burden, many can take advantage of a student loan interest deduction when filing their taxes. This deduction is an above-the-line Adjusted Gross Income(AGI) deduction that provides a tax benefit for those who go to college. The student loan
interest deduction allows you to deduct all of the interest that you paid on student loans with a maximum amount of $2,500.
This deduction is unlike most of the other deductions with which you may be familiar. Most deductions are documented on Schedule A of the return and included in the itemized deductions. These itemized deductions can then be used to reduce income if the total amount for the deductions is more than the standard deduction. The student loan interest deduction, however, is an above-the-line deduction, which allows the taxpayer to take advantage of the deduction, while also benefiting from the standard or itemized deduction.
What Qualifies as a Student Loan:
In order to apply this deduction, the IRS has determined certain criteria the loan must possess to qualify. The primary requirement is that funds from the loan had to have been used solely to pay for qualified educational expenses. These expenses include tuition and fees, room and board, books, supplies,
equipment, and other necessary expenses. The loan also had to be for you, your spouse, or your dependent. A dependent is usually your child, but there are other ways to claim someone as a dependent that can be found in IRS Publication 501. This means that if you are a parent and your child is still claimed as your dependent, you can deduct the interest you paid on their loan.
There also needs to have been a reasonable length of time in which the loan was used to pay for qualified educational expenses. These expenses are treated as paid within a reasonable time if they are paid as a part of the federal post-secondary education loan program. If they are not paid with that type of loan, there are two tests that can determine whether or not the loan has met this criteria. First, the
expenses must relate to a specific academic period. Examples include tuition for a single semester, or rent for the semester. Second, the loan proceeds are disbursed 90 days before or after an academic period. An academic period is a semester, trimester, quarter, or other period that the university uses to break up their academic year. If both of these tests are not met, there is a still a slight chance that the may qualify, but it will depend on the individual case and circumstances.
Finally, the loan must be used for education provided during an academic period for an eligible student. An eligible student is someone who was enrolled at least half time in a degree-seeking program, a certificate-seeking program, or to get another recognized educational credential.
There are a few types of loans that do not qualify for the student loan interest deduction. Loans from a related person, such as your spouse, siblings, parents, grandparents, and children do not qualify. The other type of loan that does not qualify is a loan from a qualified employer plan.
Do You Qualify to Claim the Deduction:
As long as the following tests are met, you will be eligible to claim the student loan interest deduction.
●You are filing as anything but married filing separately
●You are not claimed as an exemption on anyone else’s tax return
●You are legally obligated to pay interest on a qualified student loan
●You actually pay interest on the qualified student loan
If someone else, usually your parents, claims you for a personal exemption, neither of you may use the student loan interest deduction. Additionally, if someone else makes a payment for you, but you are the individual legally obligated to make the payments, you may still claim their payment for this deduction. The payment is still seen as having been paid by you. The amount of interest you have paid on your student loans will be provided to you by your lender on form 1098-E. In 2016, providers were only required to send out a 1098-E if the taxpayer had over $600 in
interest paid. If you paid less than $600 in interest, you can still take advantage of the student loan interest deduction, but you will have to calculate the amount by hand.
What Qualifies as Interest:
For the student loan deduction, there are a few extra items that can be included as interest: 1)the simple interest on the loan; 2) Loan Origination Fees; and 3)capitalized interest. Loan origination fees are a one-time fee that is charged when the loan is created. These fees can be for multiple things, but to be deductible the fee has to be for the use of the money. The fee is treated as interest accrues over the life
of the loan and will usually not be reported on form 1098-E. Capitalized interest is unpaid interest that is added to the outstanding principal of the loan. This type of interest is eligible for inclusion as long as payments of principal are made on the loan. You cannot deduct capitalized interest if you have not made any loan payments in that year.
There are items that may seem like they would be interest, but for the purposes of calculating your student loan interest deduction, they are not allowed. Interest that you are not legally obligated to pay on a loan is not considered eligible for this deduction. Loan origination fees for property or services offered by the lender are also not eligible. Finally, interest paid while participating in a loan repayment
assistance program is not eligible to include.
Figuring out Your Deductible Amount:
The student loan interest deduction is a deduction that includes a “phase out.” This means that once your income hits a certain level, you lose part of the deduction and eventually cannot claim any of this. This deduction phases out based on income and, remember, the level of income changes depending on your filing status. There are two different scales, the first is for single, head of household, or qualifying widow(er) filing status. If these taxpayers make less than $65,000, they may deduct all of what they paid up to $2,500. If these taxpayers make more than $80,000, they cannot deduct any of their student loan interest. If they make between $65,000 and $80,000, they may deduct a portion of their student loan interest. To find your portion that is deductible use the following formula:
Student loan interest x (Income – 65,000) = Deductible amount
For example, if you are a single filer and have $75,000 in income and paid $1,000 in student loan interest you would be able to deduct only $667.67 of that interest because of the income “phase out.” = 1,000 x (75,000 – 65,000) = $666.67
For married filing jointly the “phase-out” amounts are different. Married filing jointly taxpayers may claim all of their interest paid, up to $2,500, if there income is below $130,000. Married filing jointly taxpayers may not claim any of their student loan interest if there income is above $160,000. Married filing jointly taxpayers that have between $130,000 and $160,000 of income are subject to a “phase-out” that is similar to the other statuses. Their equation is as follows:
Student loan interest x (Income – 130,000) = Deductible amount
For example, you are a married filing jointly taxpayer with $1,500 in student loan interest and $150,000 of income. Your deductible amount would be $1,000.
=1,500 x (150,000 – 130,000) = $1,000
Once you have calculated your deductible amount, you would enter that on page 1 of form 1040, line 33. If you are having a hard time computing the deductible amount of student loan interest, the IRS has a student loan interest worksheet to help guide you step-by-step. This will be subtracted from your income and provide you with a tax benefit. The student loan interest deduction is a small way that the government is trying to provide financial assistance to those that are getting a college degree. It is unclear how long this deduction may be available for taxpayers. Under the Trump proposed tax plan that was announced, many deductions will no longer be offered. If you qualify, use this deduction while you still can.