What is a Student Loan Interest Deduction?
A student loan interest deduction is a tax deduction for the interest paid on a post-secondary education loan during the tax year in the United States. The maximum deduction is $2,500. The student loan interest deduction can be claimed by a taxpayer who takes out a student loan solely to pay for qualified education expenses.
The Internal Revenue Service (IRS) provides tax deductions that can be used to reduce the taxable income of certain taxpayers. An individual who qualifies for a $3,500 tax deduction, for example, can claim this amount against her taxable income of $20,500. Her effective tax rate would then be calculated on $17,000 ($20,500 - $3,500 = $17,000), instead of $20,500. One group of taxpayers that can relieve their tax burden by claiming deductions is students. There are certain tax credits and deductions that qualified students can claim, one of which is the student loan interest deduction.
The maximum amount of student loan interest that can be deducted in a calendar year is $2,500, subject to income limitations.
How a Student Loan Interest Deduction Works
While the principal of a student loan cannot be claimed, the interest that was paid on the loan during the tax year may be deductible under the student loan interest deduction program. The loan has to be qualified, which, according to the IRS, means that the loan must have been taken out for either the taxpayer, their spouse, or their dependent. A qualified loan is one that the taxpayer or their spouse is legally obligated to repay. Generally, loans from relatives or qualified employer plans are not qualified loans. If the student is the legally obligated borrower, a parent who helps with repayment cannot claim the deduction.
The loan must be taken out during an academic period for which the student is enrolled at least part-time in a degree program. It has to be used for qualified educational expenses, which include tuition, fees, textbooks and supplies, and equipment needed for coursework. Room and board, student health fees, insurance, and transportation are examples of college costs that do not count as qualified educational expenses under the student loan interest deduction program.
Additionally, the loan must be used within a “reasonable period of time” before or after it is taken out. Loan proceeds must be disbursed within 90 days before the academic period starts and 90 days after it ends.
To qualify for the student loan interest deduction, the educational institution that the student is enrolled in has to be an eligible institution. Under IRS rules, this includes all accredited public, non-profit and privately-owned-for-profit post-secondary institutions that are eligible to participate in student aid programs managed by the U.S. Department of Education.
Eligibility and Limitations
Up to $2,500 of the interest paid on a student loan can be deducted annually (as of 2019). If this amount is larger than the total amount of interest paid during the year, the smaller amount, i.e. the total interest paid, will be the deduction. A taxpayer who pays more than $600 in interest on student loans will receive Form 1098-E from the lending institution. The form will have the borrower’s name, address and unique taxpayer identification number. Since the student loan interest deduction is claimed as an adjustment to income, it is not necessary to itemize the deduction on Schedule A of Form 1040.
The student loan interest deduction is limited by the taxpayer's income. Student loan interest can be deducted if a single-filing taxpayer's gross income is below $65,000, and the deduction is gradually phased out as income climbs to $80,000, above which it is eliminated. For married couples filing a joint tax return, the deduction starts to phase out at $135,000 and is eliminated when income rises above $165,000. This means that a qualified single taxpayer, for example, can deduct up to $2,500 if his/her adjusted gross income falls below $65,000.
Example of a Student Loan Interest Deduction
Using a basic example, let's suppose a single taxpayer with modified adjusted gross income of $72,000 paid interest on their student loan to the tune of $900. They must figure out what their reduced deduction is. The calculation would be:
Their reduced student loan interest deduction is, therefore, $900 - $420 = $480. If their modified adjusted gross income is higher than $72,000, their deduction will be lower than $480.
If their total interest payment was $3,000, recall that the maximum deduction allowed under the student loan interest deduction program is $2,500. In this case, their maximum deduction will be reduced by:
As a result, the student’s loan interest deduction is $2,500 - $1,400 = $1,100.
Student Loan Interest Deduction vs. Student Loan Interest Tax Credit
In Canada, taxpayers can claim interest paid on student loans as a tax credit, subject to certain conditions. A Canadian taxpayer may be eligible to claim interest paid on a student loan in a given year or the preceding five years for post-secondary education, if the loan was received under the Canada Student Loans Act, the Canada Student Financial Assistance Act or similar provincial or territorial government laws.