You may be able to reduce your tax liability by hundreds of dollars by deducting interest on student loans. It is important to file the deduction correctly to maximize your savings and avoid penalties for errors.
What is the student loan interest deduction?
Similar to the mortgage interest deduction, the IRS also allows you to deduct student loan interest on your taxes – with a cap. The total savings available from deducting interest on student loans can run into the hundreds of dollars, but nearly 25% of those who pay student loans are unaware of the tax benefit.
The student loan interest deduction is available even if you do not itemize your deductions. The 2017 Tax Cuts and Jobs Act removed several deductions and increased the standard deduction, but students and graduates can still benefit from deduct up to $ 2,500 from their modified adjusted gross income.
Keep in mind that the the deduction is not a tax credit and just means less income is subject to your normal tax rate.
For example, a single filer with a modified adjusted gross income of $ 40,000 per year would be in the 22% tax bracket for 2019 and the student loan interest deduction could be worth $ 550.
Student loan interest deduction can be applied to both private and federal loans. However, it cannot be applied to interest on loans made by family members. In addition, the loan must have been borrowed for you, your spouse or your dependent for its interest to be deductible.
The IRS also requires that the loan be a qualified loan, which means that the loan should be used only for educational expenses, such as room and board, tuition and fees, books and school supplies, or transportation to / from school. Loans used for mixed purposes, such as credit card debt or other payments, are not eligible.
Only the person named on the loan can benefit from the deduction. A parent or other person who pays a loan on behalf of the student cannot claim the deduction. However, a parent with a loan in their name (on behalf of a child) may qualify for the deduction if all other eligibility requirements are met.
Besides, you cannot be declared as a dependent on someone else’s tax return. A single, married declaring jointly or head of household tax declaration status is required to benefit from the deduction, which excludes dependents and married couples declaring separately.
The student loan must be for a school that offers a degree program, although both graduate and undergraduate degree programs are eligible. A minimum half-time enrollment is also required for the deduction of student loan interest.
What it’s worth
The interest deduction on student loans is worth up to $ 550 in tax savings, depending on your tax bracket. However, if you are in the phase-out income group or in a lower tax bracket, the deduction may be worth a lower amount.
Your Adjusted Gross Income (AGI) is your gross income less allowable deductions (pension contributions, interest on student loans
The interest deduction on student loans is based on your modified adjusted gross income (MAGI). Your MAGI for student loan purposes, in most cases, is your adjusted gross income before subtracting any deduction for student loan interest. Indeed, interest is added to your income to determine your MAGI.
Your MAGI determines your eligibility for the student loan deduction:
|Sole depositor||Total deduction with MAGI less than $ 65,000||Partial deduction with MAGI equal to or greater than $ 65,000||No deduction with equal or greater MAGI|
|Married Joint deposit||Total deduction with MAGI less than $ 135,000||Partial deduction with MAGI equal to or greater than $ 135,000||No deduction with MAGI equal to or greater than $ 165,000|
|Married Filing separately||No deduction||No deduction||No deduction|
How to calculate the interest deduction on student loans
The interest deduction on student loans is a deduction above the line, which means you can take it whether you itemize your deductions or take the standard deduction. The deduction is based on a maximum interest deduction of $ 2,500. If your student loan interest for the year was $ 2,000, you can only deduct $ 2,000. If your student loan interest was $ 5,000, you can still only deduct a maximum of $ 2,500.
Unfortunately, the deduction of interest on student loans also comes with a marriage penalty. You can only deduct a maximum of $ 2,500 per return instead of $ 2,500 per person. Unfortunately, there is no way around this, as married couples who file separately cannot claim the deduction.
One thing that can complicate the student loan interest deduction formula for some tax filers is that the qualification levels are based on MAGI. This figure is different from your W-2 income and may even differ from your Adjusted Gross Income (AGI), which is your taxable income minus some allowable deductions.
To calculate your MAGI, you will need to add some of these AGI deductions to your income. Consider using software that can automate this process. The best tax packages can simplify your tax returns, minimize errors, and highlight opportunities to save money with tax deductions or credits.
If you qualify for a full deduction, simply multiply the student loan interest by your tax rate to determine how much you’ve saved.
How to claim the student loan interest deduction
If you are using tax software, carefully read the questions asked by the software. A lot of people miss the point of this deduction and leave money on the table. If you file taxes yourself, carefully read the instructions on Form 1040 as well as the instructions in Schedule 1.
Free tax software options can help you do the math, but you may need to pay a nominal filing fee if additional tax forms are required.
Documents you need
Your student lender will send out a year-end summary called Form 1098-E shortly after the first of the year. Lenders are required to send this form if you paid more than $ 600 in interest for the year. The 1098-E details the exact amount of interest you paid for the tax year, which you will need to calculate your deduction.
If you haven’t received a 1098-E, call your lender for the amount of interest paid or check your account on their website, which may have a printable summary.
You will also need the following:
- Basic income information including W-2, 1099, etc.
- Your adjusted gross income, calculated separately on your taxes
- Education fees paid with non-taxable funds
For those with overseas earned income or those residing in Puerto Rico or American Samoa, you may also need your calculated values for:
- Exclusion of income earned abroad
- Exclusion from accommodation abroad
- Deduction for accommodation abroad
- Exclusion from income by bona fide residents of American Samoa
- Exclusion of income by bona fide residents of Puerto Rico
The above values, if applicable, should be added back to your adjusted gross income, increasing your modified adjusted gross income and possibly affecting your eligibility or the value of the deduction.
Where to claim it on your tax forms
You are claiming the deduction for student loan interest on Form 1040 Annex 1.
IRS tax publication 970 (Chapter 4) provides additional guidance on how to calculate the interest deduction on student loans under different tax filing status scenarios.
The IRS also provides a worksheet for Form 1040 deductions in Schedule 1, including a section for the student loan interest deduction.
Making the Most of the Interest Deduction on Student Loans
For most students and graduates, math is fairly straightforward to calculate the interest deduction on student loans. Where it can get tricky is when your income is in the phase-out range.
Consider using tax software to supplement your taxes. Not only do software take care of the math, but the best packages also do a great job of pointing out opportunities to save with deductions or credits that many people might otherwise miss.
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