Student Loan Interest and Taxes

With the recent flood of college graduates into the workforce this spring we are reminded of an often omitted tax deduction, student loan interest. CNN late last year estimated that 59% of North Carolina graduates will graduate with student loan debt. The average for that 59% is around the $24,000 mark for student loan debt. The IRS allows a deduction for the lesser of $2,500 or amount of interest actually paid during the calendar tax year. To qualify to claim the deduction the loan must be a qualified student loan meaning that it:

(1)    Must have been taken out solely to pay qualified education expenses

(2)    Cannot be from a related person or made under a qualified employer plan

To claim the deduction on a tax return the student must be you, your spouse, or your dependent and have been enrolled at least half-time in a degree program. A dependent can be a qualifying child or relative. More information on dependents can be found here: Who can you claim as a dependent?

Keep in mind only the interest portion of the payments are deductible and not the entire payment much like mortgage interest. Student loan interest is typically reported on Form 1098-E and if not sent out by your loan provider can be obtained online or by phone. A Form 1098-E will only be issued if you paid $600 or more in student loan interest so taking further steps to get this information may be required for smaller loans.

Like a lot of tax deductions income can limit the student loan interest deduction. First, to take the deduction a married filing separately return cannot be filed. Qualifying filing statuses are single, head of household, qualifying widower, and married filing joint. For filers other than married filing joint the deduction is reduced when income is more than $65,000 and completely eliminated at $80,000. For married filing joint filers the deduction is reduce when income is more than $130,000 and completely eliminated at $160,000.

Due to the limited ability for high income earners to take this deduction there are an increasing number of supporters for repealing the student loan interest deduction. Some argue that the student loan interest deduction does not accomplish the goal of supporting higher education that the tax legislation intended. An alternative to this provision involves student loan debt forgiveness. Income-based repayment plans have provisions to provide forgiveness of outstanding loan balances after 20 or 25 years. Without a special provision the cancelled debt would be taxable to the loan holder in the year forgiven. An idea is to provide a provision that would eliminate this from income for taxpayers below a designated income threshold. This would provide relief for lower income households as well as promote timely loan repayment to avoid capturing the loan amounts into income for the average household.

As always we will stay tuned to see what happens. For now, the student loan interest deduction is here to stay so make sure it is not missed on 2013 and 2014 tax filings!