Are student loans tax deductible?

Student loans are tax deductible due to the interest accrued on the loans.

The deduction is called the Student Loan Interest Deduction. It works on qualified student loans which are loans taken out solely to pay for higher education.

Riley Holmes, a veteran tax professional at a Chicago-based H&R Block division, said that in order to qualify, the interest on student loans must have been used to pay for qualified higher education expenses such as tuition and room and board.

Tax filers who pay interest on higher education loans may be eligible to deduct up to $2,500 of interest per return each year. The $2,500 amount is the maximum set limit. Depending on a filer’s gross income, the number could reduce.

Rules

According to the IRS website, taxpayers are able to claim the student loan deduction if all of the following apply:

• You paid interest on a qualified student loan in tax year 2012
• You are legally obligated to pay interest on a qualified student loan
• Your filing status is not married filing separately
• Your modified adjusted gross income is less than a specified amount which is set annually
• You and your spouse, if filing jointly, cannot be claimed as dependents on someone else’s return

The fourth stipulation about gross income is set yearly and indexed for inflation. For the 2012 tax year, those with modified adjusted gross incomes over $60,000 are only able to receive part of the deduction. Gross incomes over $75,000 are ineligible completely. The numbers increase for joint tax returns, increasing to $120,000 and $150,000, respectively.

Holmes told loans.org that the deduction is not available to married individuals who filed a separate return from their spouse.

The final stipulation about dependents impacts borrowers that are legally still dependents of another. For example, recent college graduates with student loans who are still legal dependents of their parents are not able to file for the deduction. The deduction only works if they are claiming to be independent.

Additionally, for those with various types of student loans, the deduction works for both federal and private student loans.

“Interest paid on any student loan, including private loans, that meet the requirements can be used for this deduction,” Holmes said.

History

This income tax deduction has not always been available. The deduction was enacted in 1997 and went into effect for the 1998 year.

The amount available for a deduction has increased four times since its inception, starting at $1,000 in 1998 and increasing to $1,500 in year 1999, to $2,000 in year 2000. In 2001 it was raised to $2,500 where it remains today. Unlike other tax provisions, the amount is not indexed annually for inflation. The deduction amount is per return, not per individual limitation.

Holmes said the deduction has been it its current form since 2002 as a part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which was a part of the so-called Bush Tax Cuts. The American Tax Relief Act of 2012, which was passed just recently in 2013, made the EGTRRA provisions permanent.

“The deduction is now available indefinitely at $2,500 per year for as many years as the taxpayer pays interest,” Holmes said.

When the deduction was originally offered, it was available for 60 months worth of interest. But now things are different. Holmes said due to EGTRRA, the deduction “can be taken for an unlimited number of years and the deduction is available for voluntary payments.”

Benefits

Questions about student loan interest deductions are common question for tax preparation software programs, as well as tax professionals.

One of the reasons why it is a popular question is its ability to save young tax filers money. The Student Loan Interest Deduction reduces a tax filer’s income by $2,500 before applying the tax rate to their income, which reduces the overall amount of income that is subject to be taxed.

Furthermore, Holmes said the deduction is “above-the-line” which means that tax filers do not have to itemize in order to take it.

“This feature may be the most beneficial to recent graduates as they are less likely to have enough itemized deduction to make it beneficial to file in that manner,” he said. “For most people the largest itemized deduction is home mortgage interest.”