Are student loans tax deductible? You betcha: If you paid on student loans in the prior tax year, you might qualify for the student loan tax deduction, which allows borrowers to deduct up to $2,500 in interest they paid from their taxable income.
Getting a refund? Whether you’re considering putting it toward skydiving for the first time or you’re planning to use it to pay off more student loan debt, here are some things you should know about the student loan interest deduction and whether you qualify.
Related: Should I refinance my federal student loans?
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How the Student Loan Tax Deduction Works
The student loan tax deduction isn’t a magical discount that’s taken off your monthly student loan payment like a coupon at the grocery store checkout. Instead, you pay the interest out of pocket throughout the tax year and claim the interest you paid when you do your taxes.
The interest applies to qualified student loans that were used for tuition and fees; room and board; coursework-related fees, books, supplies and equipment; and other necessary expenses, like transportation.
So how much student loan interest can you deduct? If you qualify for the full deduction, you deduct student loan interest up to $2,500 as long as you actually paid that much in interest. (You don’t need to itemize in order to get the deduction.)
Not only do required interest payments count, but if you made any additional interest payments toward your student loans in the past tax year, those count, too.
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How to Qualify for the Student Loan Tax Deduction
To be eligible to deduct student loan interest, individuals must meet the following requirements:
- You paid interest on a qualified student loan (a loan for you, your spouse, or a dependent) during the tax year.
- Your modified adjusted gross income (gross income for the year minus certain deductions) is less than a specified amount that is set annually.
- Your filing status isn’t married filing separately.
- Neither you nor your spouse can be claimed as a dependent on someone else’s return.
- The loans in question can be federal or private student loans.
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What Are the Income Requirements for Student Loan Tax Deduction?
Your modified adjusted gross income is calculated on your federal tax return before any student loan interest deduction is made. The eligible ranges are recalculated annually.
For tax year 2020 (filing in 2021), the student loan interest deduction was worth as much as $2,500 for a single filer, head of household or qualifying widow/widower with a MAGI of under $70,000.
For those three kinds of filers who exceeded a MAGI of $70,000, the deduction began to phase out, meaning the most they could deduct was less than $2,500. Once their MAGI reached $85,000, they were no longer able to claim the deduction.
For married couples filing jointly, the phaseout began after a MAGI of $140,000, and eligibility ended at $170,000.
Confused by all these requirements? If so, consider going to a tax professional to help with your return to make sure you can take advantage of the deduction.
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Other Tax Deduction for Students
In addition to the student loan interest rate deductions, there are other tax breaks that may be available to you if you’re a student or you’re saving for or paying for certain education expenses for yourself, a spouse or a dependent.
Here’s a look.
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1. 529 Plans
A 529 college savings plan is a tax advantaged plan that allows you to save for qualified education expenses — like tuition, lab fees and textbooks — for yourself or your children. You can contribute up to $15,000 per year without triggering gift taxes, and other family members can contribute to the fund, as well.
Savings can be invested and grow tax free inside the account. And while the Federal government doesn’t offer any tax deductions, some states will tax benefits like deductions from state income tax. Withdrawals must be used to cover qualified expenses; otherwise, you will face income taxes and a 10% penalty.
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2. American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) helps offset $2,500 in qualified education expenses per student per year for the first four years of higher education. Unlike a tax deduction, tax credits reduce your tax bill on a dollar-for-dollar basis. And if the credit brings your taxes to zero, 40% of whatever remains of the credit amount can be refunded to you, up to $1,000.
To be eligible for the AOTC, you must be getting a degree or another form of recognized education credential. And at the beginning of the tax year, you must be enrolled in school at least half time for one academic period, and you cannot have finished your first four years of higher education at the beginning of the tax year.
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3. Lifetime Learning Credit
The Lifetime Learning Credit (LLC) helps pick up where the AOTC leaves off. While the AOTC only lasts for four years, the LLC helps offset the expense of graduate school and other continuing educational opportunities. The credit can help pay for undergraduate and graduate programs, as well as professional degree courses that help you improve your job skills. The credit is worth $2,000 per tax return, and there is no limit to the number of years you can claim it. Unlike the AOTC, it is not a refundable tax credit.
To be eligible, you, a dependent or someone else must pay qualified education expenses for higher education or pay for the expenses of an eligible student and an eligible educational institution. The eligible student must be yourself, your spouse or a dependent that you have listed on your tax return.
Recommended: 26 Tax Deductions for College Students and Other Young Adults
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Look for Form 1098-E
Unfortunately, you can’t deduct the entirety of your student loan payments from your taxes. As mentioned, you can only deduct your interest. Your loan provider reports information on interest paid on Form 1098-E, which is a tax form financial institutions generally send to borrowers when the tax year ends.
The only reason you wouldn’t receive one from your lender is if you paid less than $600 in interest on their loan. But these forms don’t always report things like the interest you paid on certain origination fees or capitalized interest, which may also qualify for the student loan deduction.
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How to Calculate the Student Loan Tax Deduction
To calculate the full value of the interest deduction, start with the amount of interest the form says you paid, and then add any interest you paid on qualified origination fees and capitalized interest. Just make sure these amounts don’t add up to more than the total you paid on your student loan principal.
Clear as mud, right? Hey, no one said the IRS makes things easy! Here are some examples of how to deduct these amounts.
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1. Deducting the origination fee
As of Sept. 1, 2004, this fee, usually a one-time fee that lenders charge for creating a new loan, is included on your 1098-E. For loans issued before that date, you can use any reasonable method to allocate the loan origination fees over the term of the loan. One way to do this is to figure out how much the fees will cost you monthly over the life of the loan.
Example: If the origination fee you were charged on your loan was $1,000 and the term length was 10 years, or 120 months, that would mean your origination fee would be $8.33 per month, or $100 per year.
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2. Deducting capitalized interest
If your Form 1098-E says your loan has capitalized interest, you can also claim that after you’ve claimed an origination fee deduction. Capitalized interest accrues and then is added to the loan principal if you don’t pay it. Unsubsidized federal loans, for example, accrue interest while the student is in school and during the loan’s grace period. It’s common for that interest to be capitalized (added to principal) at the end of the grace period.
Example: If you made $6,000 in student loan payments, of which $1,000 went to interest and $5,000 to principal, you can claim the $100 you paid toward your origination fee and the full $1,000 in capitalized interest. But if you only paid off $750 of your principal, you can claim $650 of the $1,000 of capitalized interest, because you’ll have to claim the $100 in origination fees first and you can’t exceed the amount you paid toward your principal.
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Tips for Lowering Your Student Loan Payments
Tax credits and deductions are one way to help pay for the cost of school. Finding ways to lower your student loan payments is another cost-saving measure. Here are a few ideas:
- Make additional payments to pay down your principal. Doing this may help reduce the amount of interest you will owe less interest over the life of the loan, but beware of any prepayment penalties.
- Make interest only payments while you’re still in school. This may prevent thousands of dollars from being added to your loan principal (or capitalized on the loan) once you graduate.
- See whether your loan provider offers discounts if you set up automatic payment. Federal Direct Loan holders may be eligible for a 0.25% discount when they sign up for automatic payments.
- Consider student loan refinancing, replacing your student loan to a new loan with a lower interest rate or more favorable terms. If you refinance federal loans, however, they are no longer eligible for federal benefits or protections.
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The Takeaway
Who doesn’t love a tax deduction? Qualified filers can take a student loan interest deduction of up to $2,500 atop the standard deduction. Most private and federal student loans are fair game.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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