Student Loan Interest Deduction

A student loan interest deduction is a tax deduction for the paid interest on a post-secondary education loan during the tax year in the United States, with 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 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 who 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.

The student loan cannot be from a related person or made under a qualified employer plan.

While a student cannot claim any student loans taken out for tuition, the interest that was paid on the loan during the 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 from relatives or qualified employer plans are not qualified loans.

The loan has to be used for qualified educational expenses which include tuition, fees, textbooks, supplies and equipment needed for 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 U.S. Department of Education.

Up to $2,500 of the interest paid on a student loan can be deducted annually (as of 2018). 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 who 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:

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:

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.