Student Loan Interest Deduction
Up to $2,500 of interest on 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 used to pay qualified educational expenses. Phaseout rules 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 legally obligated to repay the loan. A taxpayer with the legal obligation to pay the interest 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.
The American Rescue Plan Act (ARPA), signed into law in March 2021, will not treat student loans — including all federal student loans and certain private education and institutional loans, forgiven after 2020 but before 2026 — as canceled debt, subject to taxation.
Taxpayers paying student loan interest should receive Form 1098-E, Student Loan Interest Statement from any bank or government agency that received $600 or more of interest payments on the qualified student loans from the taxpayer.
Qualified expenses include those that also qualify for the deduction of tuition or other fees. These paid educational expenses 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.
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 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:
- the exclusion for foreign earned income,
- the foreign housing exclusion or deduction,
- excluded income from Puerto Rico or American Samoa, or
- any deduction for domestic production activities.
|Married Filing Jointly||$155,000||$185,000|
|Married Filing Jointly||$145,000||$175,000|
|2019 - 2021|
|Married Filing Jointly||$140,000||$170,000|
|2014 - 2018|
|Married Filing Jointly||$130,000||$160,000|
|Married Filing Jointly||$125,000||$155,000|
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.
|Student Loan Interest Deduction||=||Deductible Interest||−||Deductible Interest||×||MAGI |
− Phaseout Threshold
|Lesser of $2500 or Interest Paid =||$1,200||= Deductible Interest|
|Phaseout Range||$30,000||= Phaseout Limit − Phaseout Threshold|
|Phaseout Reduction||$800||= Deductible Interest × (MAGI − Phaseout Threshold)/Phaseout Range|
|Deductible Interest after Phaseout Reduction||$400||= Deductible Interest − Phaseout Reduction|
|Single, Head of Household, Qualifying Widow(er)|
|Lesser of $2500 or Interest Paid||$2,500||= Deductible Interest|
|Phaseout Range||$15,000||= Phaseout Limit − Phaseout Threshold|
|Phaseout Reduction||$1,667||= Deductible Interest × (MAGI − Phaseout Threshold)/Phaseout Range|
|Deductible Interest after Phaseout Reduction||$833||= Deductible Interest − Phaseout Reduction|
Employer Repayment Assistance for Student Loans
In response to the Covid-19 pandemic, Congress recently passed 2 laws, Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Consolidated Appropriations Act for 2021 (H.R. 133), signed into law on December 27, 2020, allowing employers to contribute up to $5250 annually toward an employee’s student loan until 2025, and such assistance will be free of federal and employment taxes. Employers can also offer employer paid tuition benefits of up to the same amount, but not both. The CARES Act also pauses monthly payments on privately held student loans until September 30, with no interest charges. Few companies offer student loan repayment assistance, but this may increase with the new laws.
The loan assistance must pay down the employee’s debt, not that of a spouse or child. Any amounts paid by this loan assistance cannot be deducted under the provision for the student loan interest deduction. (No double dipping!)
To offer this assistance, the employer should amend an existing written educational assistance program (EAP) or create a separate written policy satisfying the requirements of §127, Educational Assistance Programs, including not favoring highly compensated employees and employees must be notified of this assistance. The EAP also cannot allow employees to choose between educational assistance and other compensation includable in gross income.
Student Loan Cancellations and Repayment Assistance
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:
- the United States or any of its political subdivisions,
- a tax-exempt public benefit corporation, as described in IRC §501(c)(3), that has assumed control of a public hospital, or
- an eligible educational institution that has provided loans as part of an agreement with the previously mentioned qualified lenders or the loans were made to motivate students to enter occupations where a critical shortage exists, such as in healthcare or teaching, or to work in underserved areas for a specific amount of time.
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 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.
Student loans discharged due to death or disability are not included in income.
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 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 debtor cannot maintain a minimal standard of living because of the student loan debt
- the undue hardship is likely to persist for the term of the loan; and
- the debtor has made a good-faith effort to repay the loan, such as trying to modify the loan to lower the monthly payments
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