Student Loan Interest Deduction
The Student Loan Interest Deduction is an above-the-line exclusion from income on federal income tax returns for up to $2,500 in interest and fees paid on federal and private student loans during the tax year.
Since the student loan interest deduction is an above-the-line adjustment to income, it can be claimed even if the taxpayer does not itemize deductions.
The student loan interest deduction reduces the taxpayer’s adjusted gross income (AGI) and thus can yield other benefits in addition to the reduction in the taxpayer’s tax liability. For example, it can reduce the taxpayer’s state income tax liability in addition to reducing the thresholds for deducting medical expenses and unreimbursed employee business expenses.
The student loan interest deduction has an implicit marriage penalty. Although the income phase-outs for married taxpayers filing a joint return are higher than for single filers, the amount of interest that can be excluded from income does not change. This can reduce the amount of the exclusion when two borrowers get married.
The student loan interest deduction is available for an unlimited number of years.
The income phase-outs are $135,000 to $165,000 for married taxpayers filing jointly and $65,000 to $80,000 for single filers. Married taxpayers who file separate income tax returns are not eligible. The student loan interest deduction is reduced prorate within the phase-outs. The income phase-outs are adjusted annually for inflation.
The student loan interest deduction does not expire.
Qualified Education Loans
Interest that is eligible for the student loan interest deduction includes interest on qualified education loans.
Qualified education loans include federal student loans, federal parent loans, private student loans and private parent loans. Qualified education loans are borrowed to pay only for qualified higher education expenses of the taxpayer and the taxpayer’s spouse and dependents (as of the date the loan was borrowed).
Mixed-use loans, such as credit cards, do not qualify. A qualified education loan remains qualified if it is refinanced, but only if the new loan is used to refinance only qualified education loans. Qualified education loans do not include loans made by someone who is related to the taxpayer or loans from a retirement plan (a qualified employer plan).
The student must be seeking a degree, certificate or other education credential at a college or university that is eligible for Title IV federal student aid. The student must also be enrolled at least half-time. The student cannot be enrolled in an elementary or secondary school at the same time (e.g., no dual enrollment programs).
In order to claim the student loan interest deduction, the taxpayer must not be claimable as a dependent on someone else’s federal income tax return. For example, if the student can be claimed as a dependent on his or her parents’ federal income tax return, the student is not eligible for the student loan interest deduction even if his or her parents opt to not claim the student as a dependent.
The taxpayer must have a legal obligation to make interest payments on the qualified education loan to claim the student loan interest deduction based on those interest payments.
- If a parent pays the interest on their child’s Federal Stafford Loan, the parent cannot claim the student loan interest deduction because the parent was not obligated to repay the Federal Stafford Loan. The parent’s payments count as though they were made by the borrower (i.e., they are treated as a gift to the borrower who then made the payments). However, if the borrower can be claimed as a dependent on the parent’s federal income tax return, the borrower is not eligible to claim the student loan interest deduction on the borrower’s federal income tax return.
- If a parent pays the interest on a Federal Parent PLUS loan or on a private education loan that was borrowed or cosigned by the parent, the parent can claim the student loan interest deduction because the parent is legally obligated to repay the debt.
Voluntary Payments of Interest
Voluntary payments of interest at times when it was not due will nevertheless qualify for the student loan interest deduction. For example, if the taxpayer paid interest during a deferment period, grace period or forbearance period, the interest is eligible for the student loan interest deduction even though the borrower was not required to make a payment of interest during these periods. However, accrued but unpaid interest does not qualify for the student loan interest deduction until it is paid. Loan fees and capitalized interest that are added to the loan balance are treated as being paid over the life of the loan, as part of each principal payment.
Payments Made by Third Parties
Payments made by third parties are treated as if they were made by the borrower. The payments are treated as a gift from the third party to the borrower, who then makes the payments.
If the taxpayer’s employer makes payments on the taxpayer’s qualified education loans, the payments are included in the taxpayer’s gross income. The payments are treated as though they were made by the taxpayer. Accordingly, the taxpayer is eligible for the student loan interest deduction based on the interest portion of the payments made by the employer.
Qualified Higher Education Expenses
Qualified higher education expenses include tuition and fees, room and board, books, supplies and equipment, transportation to/from college and other expenses included the college’s cost of attendance. Room and board expenses are capped at the allowances in the college’s cost of attendance. However, if the student is living in housing owned or operated by the college, the room and board expenses may be the actual amount charged by the college, if greater than the allowance.
Qualified higher education expenses are reduced by the amount of expenses for which an education tax benefit was received, such as the tax-free portion of a scholarship, tax-free employer-paid tuition assistance and tax-free distributions from 529 college savings plans, prepaid tuition plans and Coverdell Education Savings Accounts. Qualified higher education expenses are also reduced by certain military student aid benefits provided by the federal government for veterans and members of the U.S. Armed Forces.
The qualified higher education expenses must have been paid or incurred within a “reasonable amount of time” before or after the loan was borrowed, typically within 90 days.
Coordination restrictions prevent double-dipping. If the interest on a qualified education loan could be deducted under any other tax benefit, it is not eligible for the student loan interest deduction. For example, the interest on a home equity loan or line of credit is not eligible for the student loan interest deduction, even if the loan is used exclusively for qualified higher education expenses.
How to Claim the Student Loan Interest Deduction
The Student Loan Interest Deduction is claimed on the taxpayer’s federal income tax return. The taxpayer must file IRS Form 1040 or IRS Form 1040A to claim the student loan interest deduction. Taxpayers will receive IRS Form 1098-E, Student Loan Interest Statement, from their lenders if they paid $600 or more in interest on a qualified education loan.
A good source of additional information is Chapter 4 of IRS Publication 970, Tax Benefits for Education. The statutory language appears in the Internal Revenue Code at 26 USC 221. The current regulations can be found at 26 CFR 1.221-1 and 26 CFR 1.6050S-3.
The IRS publishes an online tool that can be used to determine eligibility for the student loan interest deduction.