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Student Loan Interest Deduction Explained

Student Loan Interest Deduction Explained

Tax season brings mixed feelings. You can get a refund, but you can also get an IRS bill. It's not fun, especially when a big chunk of your budget is spent on student loans.

But the IRS offers a student loan interest deduction to provide tax benefits to student borrowers.

It's true: you may be able to write off the interest on your student loan each year.

In this article, we'll explain the student loan deduction and help you see if you might qualify for one. We'll discuss other tax incentives students can consider and provide non-tax tips for reducing the debt burden and student loan repayments during and after college.


What is the student loan interest deduction?

According to the Education Data Initiative, the average student loan repayment term is 20 years, and borrowers accumulate an average of $26,000 in interest.

The IRS recognizes that $26,000 is a lot of money, and they also realize that you are borrowing for skills and education that will benefit you and the economy. So they created a student loan interest deduction, a tax incentive that can allow you to deduct interest paid on student loans.

Please note that the entire payment of your student loan is not tax-deductible, only the interest portion.


How does the student loan interest deduction work?

The student loan interest deduction allows you to deduct up to $2,500 of interest paid on qualifying student loans each year. If you paid less than $2,500, you could only deduct up to the amount paid.

For example, if your interest payments on qualifying loans are $3,000, you can deduct $2,500.

On the other hand, if you only paid $1,000 of qualifying interest, you can only deduct $1,000 from your income.

The student loan interest rate is considered an adjustment to your income, also known as the "over the line" deduction. This means you don't have to itemize deductions to claim them, as you would with many other types of tax deductions.

This is also a deduction, not a credit. This means that you reduce your taxable income. It does not directly reduce taxes dollar for dollar, as a tax credit would.

For example, imagine making $50,000 this year and paying $2,500 in interest on qualifying student loans. It does not reduce the taxes due by $2,500. Instead, it reduces your earnings by $2,500 from $50,000 to $47,500.


Am I entitled to a student loan interest deduction?

According to IRS publication 970, you can claim the deduction if:

  • No one else claims you as a dependent on their tax return

  • You are legally required to pay interest on an eligible student loan, and you did so during the fiscal year

  • You claim any filing status except married filing separately (e.g.: single, head of household, married filing jointly)

Both federal and private loans are good for this deduction if you meet the above conditions.

This deduction also has income limits if you earn a lot, and these limits can change each year due to inflation. The IRS looks at the modified adjusted gross income, or MAGI, to see if you earn a lot.

The IRS has a worksheet in its Publication 970 that walks you through calculating MAGI. However, why go through such rigorous tax when a tax expert can help you out.


How to claim a student loan interest deduction if you qualify

If you qualify and pay more than $600 in student loan interest during the fiscal year, your loan servicer will provide you with a tax form called 1098-E.

This form must have all interest paid on all loans the debt collector handles.

This number goes to Schedule 1, line 21, which says Student loan interest deduction. It is then used along with all other entries in the worksheet to find the total income adjustments included in the 1040 tax return.

If you paid less than $600, you could still qualify; you will need to contact your loan officer to find out the interest you paid.

If you have more than one creditor, you will receive a 1098-E from each person you paid at least $600 in interest on the loan.


Other Ways to Reduce the Student Loan Burden

Tax cuts aren't the only way to save interest and get rid of student loan debt faster. Try the following options and tips to get more opportunities for your student loan repayments.


Seek debt-free aid

If you are still in school, choose non-debt financial aid because you do not have to repay this type of aid.

Grants are a good starting point. These are need-based, meaning they are awarded based on the winner's ability to pay for their education.

After that, look for scholarships. These are usually merit-based and help you close the gap if the grants aren't giving you all the help you need.

You can also find many scholarships online and through your school's financial aid office. Some require essays, while others simply require you to complete a short form.


Consider loan forgiveness programs.

Loan forgiveness programs completely forgive your loans if you have qualified federal loans, repay the loans on time for a certain number of years, and meet other requirements.

Loan forgiveness is generally only available for federal loans. Private loans don't usually count.


Consider income-based payment plans.

If your monthly federal loan payments are high relative to your income, your income-based repayment plans can help. There are 4 kinds:

  • Income contingent repayment plan

  • Pay as you earn repayment plan

  • Payment plan based on income

  • Revised pay as you earn repayment plan

They adjust your payment based on your income and family size so you can continue to make the necessary payments on time.

Each type of income-based plan also provides loan forgiveness after making timely payments for 20 to 25 years, depending on the plan and loan usage.


Refinance your loans

Refinancing consists of repaying an existing loan with a new loan with a lower interest rate, which reduces the monthly payment. This can be a good option if you have private loans, as these loans cannot be forgiven.

For example, if you still have $10,000 in student loans at 5% interest, refinancing could result in $10,000 in loans at 3.5% to pay off the old loan. You still have $10,000 in debt, but with the lowest interest rate of 3.5%.

You pay less interest, which reduces your potential tax deduction. However, you will save a lot more money in the long run.

That said, not everyone has a good enough credit score to be immediately refinanced. Continue to repay the loan on time to gradually increase your score, then refinance later when the score is good enough.


Pay off loans while you're in school.

Pay off some of your loans while in school if you can. Reducing your principal balance early means paying less interest.

This is especially true for adverse loans, which only start earning interest at the end of the 6 month grace period. You can earn a decent dent in the loan if you are ready to start repaying these loans sooner.

Working to earn money while in school is a great way to get started on your loans. Creating a budget can help you find other ways to save money that you can use to repay your loans.


Pay the interest on the loan and get a tax exemption

Student loan repayments can consume a large portion of your monthly budget. Fortunately, the IRS allows you to waive this interest to reduce your tax bill or increase your refund.

Regardless of your eligibility for a tax deduction for student loan interest, many other options are available to save on college fees, including tax credits, college savings plans, and student loan repayment assistance. 

For more ways to reduce your debt burden before, during, and after college, consider talking to a financial expert to help you with the right option.


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