Student Loan Interest Deduction

Up to $2,500 of qualified student loans may be claimed as an above-the-line deduction — meaning the deduction is not an itemized expense — by lower income taxpayers if they were used to pay qualified educational expenses. There are phaseout rules that limit the deduction for upper income taxpayers.

A taxpayer is eligible to claim the deduction of the lesser of the actual interest paid or $2,500 if she is legally obligated to pay the loan. As long as the taxpayer has the legal obligation to pay the interest, then the taxpayer can claim the deduction, even if someone else pays the interest on the taxpayer's behalf. However, anyone claimed as a dependent by another taxpayer or a married couple filing separately cannot claim the deduction.

Taxpayers who are paying student loan interest should receive Form 1098-E, Student Loan Interest Statement from any bank or government agency that received $600 of more of interest payments on the qualified student loans from the taxpayer.

Generally, qualified expenses include those that also qualify for the deduction of tuition or other fees. These educational expenses that are paid must have been incurred either before or shortly after the loans were taken out and the student must be enrolled at least half-time in a program leading to a degree or other recognized credential at a college, university, vocational school, or other postsecondary educational institutions that participate in student aid programs administered by the Department of Education. Graduate school programs are also included, as well as medical internships or residency programs.

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Qualified expenses include tuition, fees, room and board, books, equipment, and other necessary expenses, such as transportation. However, any of these expenses must be reduced by any other tax benefits received from other programs such as Veterans' education assistance benefits, nontaxable employer-provided educational assistance benefits, or Coverdell Education Savings Account or Qualified Tuition Program (QTP) distributions, qualified tax-free scholarships, and excluded interest from United States savings bonds.

Deductible interest includes loan origination fees and capitalized interest. Even voluntary interest payments are deductible when made by taxpayers who have been granted a deferment in payment.

A revolving line of credit is not considered a qualified loan unless all of the funds are used to pay educational costs. Additionally, the loan cannot have come from a relative, a qualified employer plan, or where the interest can be deducted under some other provision of the tax law, such as the home mortgage interest.

The deductibility of student loan interest is limited by the modified adjusted gross income (MAGI) of the taxpayer. MAGI equals adjusted gross income (AGI) before deducting student loan interest minus:

MAGI Limits for Claiming a Student Loan Deduction
Phaseout
Threshold
Phaseout
Limit
2014 - 2018
Married Filing Jointly$130,000$160,000
All Others$65,000$80,000
2013
Married Filing Jointly$125,000$155,000
All Others$60,000$75,000
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The MAGI for the student loan interest deduction is calculated in the same way as the deduction for directly paid expenses. The phaseout reduction is calculated by multiplying the MAGI minus the lower income limit divided by the upper income limit minus lower income limit. The deduction can be figured on the Student Loan Interest Deduction Worksheet in the instructions for Form 1040, Form 1040A, or Form 1040NR.

Formula for Student Loan Interest Deduction Subject to Phaseout Rules
Student Loan Interest Deduction = Deductible InterestDeductible Interest×MAGI – Phaseout Threshold
Phaseout Range
  • Deductible Interest = Lesser of (Paid Student Loan Interest or $2,500)
Example: Calculating the Student Loan Interest Deduction According to MAGI
Joint Filer
Interest Paid$1,200
Lesser of $2500 or Interest Paid =$1,200= Deductible Interest
MAGI$140,000
Phaseout Threshold$120,000
Phaseout Limit$150,000
Phaseout Range$30,000= Phaseout LimitPhaseout Threshold
Phaseout Reduction$800= Deductible Interest × (MAGIPhaseout Threshold)/Phaseout Range
Deductible Interest after Phaseout Reduction$400= Deductible InterestPhaseout Reduction
Single, Head of Household, Qualifying Widow(er)
Interest Paid$3,000
Lesser of $2500 or Interest Paid$2,500= Deductible Interest
MAGI$70,000
Phaseout Threshold$60,000
Phaseout Limit$75,000
Phaseout Range$15,000= Phaseout LimitPhaseout Threshold
Phaseout Reduction$1,667= Deductible Interest × (MAGIPhaseout Threshold)/Phaseout Range
Deductible Interest after Phaseout Reduction$833= Deductible InterestPhaseout Reduction

Student Loan Cancellations and Repayment Assistance

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Generally, a cancellation of a loan is a taxable event, in that, unless the tax code provides otherwise, the borrower must include the amount that was canceled in his gross income in the year of the cancellation. However, the cancellation of student loans may be tax-free if they were qualified loans provided by qualified lenders, which includes:

Section 501(c)(3) organizations include those whose objective is charitable, religious, educational, scientific, literary, public safety testing, to prevent cruelty to children or animals, or to promote national or international amateur sports competition.

A qualified loan is one that was provided so that the student can attend an eligible educational institution and where a condition of the loan was that all or part of the debt would be canceled if the borrower worked for a minimum duration in specified professions — usually where a shortage exists — for a specific group of employers. However, any loan that was canceled because of services provided by the borrower is includable in the borrower's income.

Repayment assistance is also tax-free if provided by a state program to promote the availability of health services in underserved areas, a state program that is eligible under the Public Health Services Act, or by the National Health Service Corps Loan Repayment Program.

Tip: Apply for Government Loans before Applying for Private Loans

Federal government student loans pose less risk for the borrower than private student loans, because federal loans can be modified if the payments later turn out to be unaffordable. Other options with federal loans include the ability to have the loans forgiven, if the school is closed permanently or under other special circumstances. Instead, the student could opt to transfer to another school with a similar program, but than the previous loans will not be forgiven. Although loans from private lenders may be discharged through a process called the borrower defense-to-repayment strategy, (sometimes just called the borrower defense) it may not be successful. The borrower defense can be invoked if the school committed fraud, misrepresented its services, failed to fulfill its legal requirements, or otherwise violated state law governing the the loans or educational services. Note, also, that veterans using the G.I. Bill to fund education will lose the funds spent if the school is closed or provides an inadequate education.

Student loan debts are generally nondischargeable in bankruptcy unless the taxpayer can show that the debt imposes an undue hardship. The courts of most states rely on the Brunner test [Brunner v. New York State Higher Educ. Servs. Corp., 831 F. 2d 395 (2d Cir. 1987)] to determine whether there is an undue hardship:

The problem with government guaranteed loans is that they keep raising the limit and schools keep raising their tuition to increase their profits, trying to extract as much money as possible from the governments. Additionally, schools strive to get as many students as possible whether they really qualify for schooling or not. The schools generally do not care because if the students cannot repay their loans, it will not be their problem, since their only interest is increasing profits. This may soon change, since the government wants to reduce funding to schools with graduates who are failing to get jobs that pay well enough to repay their loans. In any case, if you do obtain a school loan, get loans directly from the federal government before turning to private loans, since government agencies are more likely to modify the terms of the loan to make them more affordable.

More information: Forgiveness, Cancellation, and Discharge | Federal Student Aid