Student loans have garnished a significant portion of the national media attention lately, and rightfully so. 7 out of 10 students are graduating with student loan debt and the total amount of outstanding student loan debt is over 1.3 trillion dollars. Yes, you read that right, trillion.
As more students are entering college every year, the competition for jobs continues to increase. This competition results in graduates taking low-paying jobs that they are overqualified for. Many of these people, as a result, struggle to repay their educational debt and are looking for ways to save.
One way student loan borrowers can save some money during repayment is by deducting interest payments on their federal income tax returns.
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What is the Student Loan Tax Deduction and Who is Eligible?
The Internal Revenue Service (IRS) allows for a maximum reduction of $2,500 annually. We created this interest deduction calculator to estimate tax reductions in specific scenarios. In short, the amount you can deduct from your taxes depends on your adjusted gross income, or AGI. Your AGI is calculated as your gross income minus adjustments to income for that year. Any interest payments can be counted; including the minimum required payment as well as any additional payments you may have made.
Borrowers are only eligible if they attended a higher institution that is eligible for Title IV federal student aid—which includes most colleges and universities in the nation. In addition, they must have attended their colleges at least half-time.
Those with an AGI of less than $65,000 are eligible for the full $2,500 tax deduction. Those who make more than that, but less than $80,000, can deduct some of their interest but not the entire amount. Where you fall in that range will determine your allowable deduction. Those with an AGI of over $80,000 are not eligible for the student loan interest tax deduction.
If you are married and file your taxes jointly with your spouse, you collectively cannot make more than $160,000 to be eligible. Also, though it may not make sense, you both are only eligible for a maximum of $2,500 together, not $5,000.
Only interest that has already been paid towards a student loan from a qualified lender can be counted in the interest deduction. If you have interest that has accrued, but you haven’t made payments towards it yet, you cannot claim this. Furthermore, interest paid to any non-qualified sources cannot be counted, such as family members or an employer who loans money to pay for college.
If your parents help pay for your student loans, but the loans are in your name, only you can claim the tax deduction because you are the one legally obligated for repayment. You could, of course, pay your parents for any money you save from the deduction if they were hoping to receive it. The one exception is if the parents cosigned the loans. In this case, the parents can claim the interest deduction.
One other caveat to the tax deduction is that borrowers who are claimed as dependents on their parents’ tax returns are not eligible. In this case, neither the parents nor children can claim the deduction, unless the parents cosign the loan, in which they may be eligible.
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What is the 1098-E Student Loan Tax Form?
Form 1098-E is a special tax document from the IRS that is specifically designed for reporting student loan interest. For those who don’t know, student loan interest is tax deductible, so you can potentially catch a break every tax season. If you have student loans and have been making payments, then there is a solid chance that you will receive Form 1098-E in the mail.
While receiving Form 1098-E in the mail is an eligibility indicator, it does not actually mean you are officially eligible for tax deduction; nevertheless, you should fill it out regardless. Here are a couple rules of thumb to keep in mind when filling out the 1098-E Student Loan Tax Form.
You must have paid at least $600 in interest to receive the tax form, and the maximum deductible amount is $2,500 in interest payments. The 1098-E process might be a little confusing if you have multiple student loans; for instance, there is a chance that you receive a Form 1098-E for every outstanding loan. Despite this issue, your eligibility for Form 1098-E is based on interest paid over all outstanding loans.
In short, Form 1098-E is how you report qualified student loan interest payments.
Can I Claim Interest Payments on Refinanced Student Loans?
Yes! There is a common misconception that once you refinance your student loans with a private lender, that you can no longer claim your student loan interest payments on you taxes. This isn’t true, however! You can deduct interest payments made towards any type of student loans, federal and private.
Even though the IRS is a federal agency, private student loan interest payments are still eligible for tax deductions. As long as you meet the requirements above, you are good to go. If you refinance in the middle of the year, all interest payments both before and after are eligible, even if your interest rate changed. If you are considering refinancing your federal student loans, don’t fall into the trap of believing you won’t be eligible for tax deductions just because you now have a private student loan!
Should I Make Only Minimum Interest Payments So I Can Prolong My Eligibility?
No. It would be financially inefficient to prolong your student loan payments just so you can take advantage of the tax deduction for a longer period of time. You would save more money paying off your student loans as fast as possible. The longer you have your loans, the more interest that accrues and the more you will end up paying.
In addition, the student loan tax deduction won’t save you that much money. There is a common misconception with the student loan interest deduction, and tax deductions in general. You are not receiving a credit that reduces total amount of taxes you have to pay; you are receiving a deduction on your taxable income. For example, if you make $50,000 a year, the deduction will take your taxable income down to $47,500. It would be incorrect to think that you would only have to pay $7,500 in taxes if you were initially required to pay $10,000.
What are Some Other Ways to Save Money on Student Loan Repayment?
Though interest rate deduction is an easy way to save some money on your student loan repayment, there are many other options to consider as well. The one with the most potential for savings is student loan refinance. When you refinance your student loans, a private lender pays off your current loans and gives you a new one with new terms. Depending on your situation, you may receive a lower interest rate or longer repayment term. Though only those who have a good credit score are eligible, refinancing could save you thousands over the life of your loan! Here at LendEDU, we allow borrowers to compare prequalified quotes from up to 13 lenders with one easy, free application.
Aside from refinancing, you may be eligible for other federal benefits if you meet certain criteria. One of the most popular is Public Service Loan Forgiveness, or PSLF. Those who work in a public service job for at least 10 years and have made at least 120 qualifying payments towards their student loans may be eligible. If you are eligible for PSLF, your loans will be completely forgiven and you won’t have to repay your student loans anymore!
There are also many other forgiveness programs that the government offers. To learn more and to see if you are eligible, check out our complete guide here. Finally, if you want to learn more about repaying your student loans after graduation and our secret tips to saving money, check out our in-depth guide.
Whether the government is the source of our nation’s student loan problem or not, it is nice to see they are trying to help borrowers in some form. While the interest deduction won’t cover all of your student loan payments, every bit helps. If you are currently in the repayment phase, there is no reason not to take advantage of the deduction if you are eligible. Also, be sure to keep in mind that you are still eligible for this benefit even if you refinance your student loans!
Check out our Student Loan Interest Tax Deduction Survey to learn more about how borrowers feel about the deduction and how they spend the money they save through it.
Author: Mike Brown
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