DEFINITION of 'Student Loan Interest Deduction'

Student Loan Interest Deduction is a tax deduction for interest paid on post-secondary education loans during the tax year in the U.S., the deduction amount being the lesser of $2,500 or the actual interest paid. The student loan interest deduction can be claimed by the taxpayer if the student loan was taken out solely to pay qualified education expenses; the loan cannot be from a related person or made under a qualified employer plan.

BREAKING DOWN 'Student Loan Interest Deduction'

The Internal Revenue Service (IRS) provides tax deductions that can be used to reduce the taxable income of certain taxpayers. For example, an individual who qualifies for a $3,500 tax deduction can claim this amount against her taxable income of $20,500. Her effective tax rate would then be calculated on $20,500 - $3,500 = $17,000, instead of $20,500. A group of taxpayers that can relieve their tax burden by claiming deductions is the student group. There are certain tax credits and deductions that qualified students can claim, one of which is the Student Loan Interest Deduction.

Qualifying for Student Loan Interest Deduction

While a student cannot claim any student loans taken out for tuition, the interest that was paid on the loan during they tax year can be deductible with 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, his/her spouse, or his/her dependent. Also, the loan must have been taken out for educational purposes during an academic period for which the student is enrolled at least part-time in a degree program. A qualified loan is one that the taxpayer or his/her spouse is legally obligated to repay, and the loan must be used within a “reasonable period of time” before or after it is taken out. The loan proceeds used for educational expenses must be disbursed within 90 days before the academic period starts and 90 days after it ends. Generally, loans gotten from relatives or qualified employer plans are not qualified loans.

The loan has to be used for qualified educational expenses which include costs for tuition, fees, textbooks, and supplies and equipment needed for the coursework, etc. Room and board, student health fees, insurance, and transportation are examples of costs that do not count as qualified educational expenses under the student loan interest deduction program.

To qualify for the student loan interest deduction, the educational institution that the student is enrolled in has to be an eligible institution. An eligible school, under IRS rules, 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 US Department of Education.

Eligibility and Limitations

Up to $2,500 of the interest paid on a student loan can be deducted annually (as of 2017). If this amount is larger than the total amount of interest paid during the year, the smaller amount i.e. interest total paid, will be the deduction. A taxpayer that pays more than $600 in interest on her 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 cannot be deducted if the taxpayer's gross income exceeds $80,000, or if filing a joint tax return with a spouse, $160,000. A taxpayer who earns between $65,000 and $80,000 will have the deduction slowly reduced (phased out) until s/he reaches the upper limit. This means that a qualified single taxpayer can deduct up to $2,500 if his/her adjusted gross income falls below $65,000. This limit is reduced if he falls within the $65,000 to $80,000 range, becoming smaller as the income level approaches the upper limit. This rule also applies to a taxpayer that is married and filing jointly with adjusted gross income between $130,000 and $160,000.

Using a basic example, suppose a single taxpayer with modified adjusted gross income of $72,000, paid interest on his student loan to the tune of $900. He must figure out what his reduced deduction is. The calculation would be:

Student Loan Interest Deduction Calculation with an interest of $900

His reduced student loan interest deduction is, therefore, $900 - $420 = $480. If his modified adjusted gross income was higher than $72,000, his deduction will be lower than $480.

If his total interest payment was $3,000, recall that the maximum deduction allowed under the student loan interest deduction program is only $2,500. In this case, his maximum deduction will be reduced by:

Student Loan Interest Deduction Calculation with an interest of $3000

And the student’s loan interest deduction will be $2,500 - $1,400 = $1,100.

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.

  1. Interest Deduction

    Interest deduction causes a reduction in taxable income or revenues ...
  2. Tax Deductible Interest

    A borrowing expense that a taxpayer can claim on a federal or ...
  3. PLUS Loan

    A PLUS loan is a federal student loan where the parent borrows ...
  4. Standard Deduction

    The IRS standard deduction is a portion of income that is not ...
  5. Schedule A

    Schedule A is a U.S. income tax form that is used by taxpayers ...
  6. Mortgage Interest Deduction

    A common itemized deduction that allows homeowners to deduct ...
Related Articles
  1. Personal Finance

    Can I Pay Off Student Loans with My 529 Plan?

    Not yet. A bill that would let people use 529 plans to pay off student loans is working its way through Congress.
  2. Financial Advisor

    Federal Direct Loans

    These are the most popular type of federal student loan. Read this guide to the types you can get, how much you can borrow and repayment options.
  3. Taxes

    Increase Your Tax Refund With Above-The-Line Deductions

    Find out about these deductions and how you can use them to lower your tax bill.
  4. Personal Finance

    Managing Student Loans: 3 Things to Consider

    You can better manage the burden of student loan debt by following these three steps.
  5. Personal Finance

    Fund Your Schooling with PLUS Loans

    Find out what they and are whether you're eligible to apply for these no-maximum loans.
  6. Personal Finance

    10 Ways Student Debt Can Destroy Your Life

    If you're getting a student loan, think critically about how you will manage your loan. Student debt could have a profound negative impact on your life.
  7. Taxes

    Good News for MBA Students Seeking a Tax Deduction

    A court's recent ruling in favor of a temporarily unemployed MBA candidate is giving hope to others seeking tax deductions for students.
  8. Personal Finance

    Shocking Spike in Federal Student Loan Defaults

    The cost of college keeps going up and graduates are finding it tough to land good jobs.
  9. Taxes

    Top Tax Deductions Not to Overlook

    If you want to pay as little as possible in taxes, it's important to learn about all the different credits and deductions available. Here's a primer.
  10. Personal Finance

    American Debt: Student Loan Debt Up $21 Billion

    It isn’t news that student loan debt is large and growing, up $21 billion in Q4. What would be news is a solution to the problem.
  1. Is the interest on my student loan tax deductible on my federal income taxes?

    Find out how you can deduct interest payments for qualified student loans from your income taxes, and learn about restrictions ... Read Answer >>
  2. Are Student Loans Tax-Deductible?

    Learn how and when to deduct the interest on student loan payments, which allows individuals to reduce their taxable income ... Read Answer >>
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center