Federal income tax deductions offer a helping hand to student loan borrowers, providing the opportunity to eliminate up to $2,500 of interest paid on qualifying student loans from their taxable income. This provision offers a crucial financial boost to those navigating higher education expenses, provided they meet certain eligibility requirements.
Detailed by the Internal Revenue Service (IRS), these tax deductions allow borrowers to reduce their yearly taxable income. The student loan interest deduction permits a subtraction of up to $2,500 of the interest paid on a student loan within a tax year.
Borrowers who earn a modified adjusted gross income (MAGI) of not more than $75,000 have the opportunity to claim up to $2,500. This deduction amount is gradually less for those earning between $75,000 and $90,000. Unfortunately, for those earning $90,000 and above, they are ineligible for the deduction.
This stipulation offers significant advantages for those earning within the 22% tax bracket. Individuals in this category can take full advantage of the $2,500 deduction or the equivalent of their actual student loan interest payment, whichever is lower.
To qualify for the deduction, the loan must meet specific requirements. For example, IRS Publication 970 highlights that the borrower must meet certain stipulations in order to claim the deduction.
Unlike many deductions which require a Schedule A to itemize them, the student loan interest deduction is an adjustment to income. This means it can be claimed on Form 1040 without any extra paperwork.
If a borrower pays less than $2,500 of interest on an eligible student loan within the year, their deduction will equal the amount they actually paid. If the interest exceeds $600, the lending institution should provide a Form 1098-E. Not to worry-if it doesn't, the form can be downloaded directly from the IRS website.
Higher earning taxpayers should note, the student loan interest deduction reduces or nullifies according to income levels. For 2023, the deduction gradually scales down or phases out for single filers earning a MAGI between $75,000 and $90,000. It falls between $155,000 and $185,000 for those filing jointly. The deduction cannot be claimed if your income exceeds these limits. The income cap for the student loan interest deduction adjusts annually for inflation.
There are other tax incentives available for students and parents, such as tax credits, alongside the student loan interest deduction. Tax credits directly subtract from the tax debt, providing greater value.
The American Opportunity Tax Credit (AOTC) provides a credit for eligible expenses paid for a student's initial four years of higher education. This is capped at $2,500 per student per year.
On the other hand, the Lifetime Learning Credit (LLC) provides a maximum tax credit of $2,000 per return. This can be availed by students paying for an undergraduate, graduate, or professional degree. There's no limit to how many years the credit can be utilized.
Tax benefits are also available through 529 Plans. These savings plans provide tax advantages for parents saving for their children's education. The Tax Cuts and Jobs Act of 2017 expanded the definition of approved education-related expenses, and the SECURE Act of 2019 added apprenticeship program costs and loan repayments to this.
President Trump suspended federal student loan payments interest-free during the coronavirus crisis, a pause later extended by President Biden until December 31, 2022. This hiatus resumed in October 2023 and could impact interest payments deducted from federal student loans.
President Biden's American Rescue Plan, enacted on March 11, 2021, rendered all forms of student loan forgiveness tax-free from January 1, 2021, until the end of 2025.
Let's consider an example to illustrate how these deductions work. If a single taxpayer with a MAGI of $72,000 paid $900 in student loan interest, then their deduction would be calculated as follows:
$900 x [($72,000 - $65,000) / ($80,000 - $65,000)] = $420 This $420 is the disallowed portion of the $900 interest. Subtracting it from the full $900 results in an allowable deduction of $480.
IRS Publication 970 includes a worksheet to calculate the modified adjusted gross income and student loan interest deduction. This allows borrowers to subtract up to $2,500 of paid loan interest from their taxable income, therefore diminishing the tax owed to the government.
Loans must fulfill certain eligibility criteria, such as the loan having been used for approved higher education expenditures and the school participating in the Department of Education's student aid program.
Figuring out the details of the student loan interest deduction can grant borrowers the ability to lessen their taxable income by up to $2,500. The point when this deduction begins to phase out and eventually becomes unavailable is dependent on the tax filer's income and filing status.