With more than 70 percent of the country’s latest degree recipients using student loans to pay for their recently earned degrees, understanding student loans has become more important than ever.
One of the only benefits is that you can deduct interest paid on those loans.
But like many of the rules in our complicated tax code, student loan interest does not apply to everyone — or to every loan. The good news is that you can deduct interest on your student loan even if you don’t itemize your deductions. This is especially helpful since many recent grads aren’t likely to be homeowners who itemize their deductions.
For a breakdown of student loan interest, here are some helpful tips.
Who qualifies and who doesn’t?
You can deduct up to $2,500 of student loan interest paid in a given year. As with many tax rules, there is an income limit to this deduction.
Your modified adjusted gross income cannot be more than $80,000 (or $160,000 for married couples filing jointly). If you earn between $65,000 and $80,000 (or $130,000 to $160,000 for married filing jointly), the deduction is slowly reduced until you reach the upper limit.
You can only deduct loans if they were loaned to you from a qualified source. If your parents loaned you $10,000 for college, you can’t deduct the interest you pay them on your taxes. If your employer lends you money for your schooling, that amount is also not eligible for student loan interest deductions.
You can deduct interest that you paid on both the minimum payments and any extra payments you make toward your loans.
The loan taken out has to be for yourself, a spouse or a dependent. Whoever is receiving funds for their education has to be enrolled at least part-time to be eligible for the interest to be deducted.
The loan money must be used within what the IRS calls a “reasonable amount of time” on qualified education expenses. Sometimes there is a question of whether the parent or student can take the deduction. For the IRS, they say whosever name is on the loan is the one who can take the deduction.
You also have to make sure that whatever place you attended or graduated from is an “eligible educational institution” according to the IRS. You can only deduct interest if you attended a university with that designation.
There are some other factors to consider when filing your taxes. You can file any status you want, except for married filing separately. If you are married and filing jointly, you can still only deduct up to $2,500 in interest, even if both of you are paying back loans.
What are some other factors to consider?
One factor to take into account is that you don’t want to put off paying off your student loans early just to take advantage of the tax deduction. Remember, it’s still a deduction – not a tax credit. What’s the difference? A tax credit would be amount that you could deduct from the total you owe on your returns. A deduction on your taxes reduces your total taxable income. They’re both helpful, but a deduction is only a partial refund on the amount you paid into.
Basically, there’s no point in prolonging your student loan payments solely to take advantage of the tax deduction. It’s still better to pay off your student loans as quickly as you can, even if your tax return will decrease afterwards.
To see if you’re eligible to deduct student loan interest on your taxes, take a look at the IRS website for more information.