After the outcry from students, colleges, and universities at the end of 2017, the final version of the Tax Cuts and Jobs Act preserved the student loan interest tax deduction. Although the tax deduction won’t significantly reduce the overall cost of borrowing, every bit helps.
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Student loans have garnished a significant portion of the national media attention in recent years, and rightfully so: Seven out of 10 students are graduating with student loan debt, and the total amount of outstanding student loan debt is over $1.5 trillion dollars, according to our student loan debt statistics. Yes, you read that right — trillion.
As more students enter college every year amid rising higher education expenses, the competition for jobs continues to increase. This competition results in graduates taking low-paying positions for which they are overqualified. As a result, many of these people struggle to pay off student loans and are looking for ways to save.
One way student loan borrowers can save some money during repayment is by deducting student loan interest payments on their federal income tax returns.
On this page:
- What is the Student Loan Interest Deduction?
- Who is Eligible for the Student Loan Tax Deduction?
- What is the 1098-E Student Loan Tax Form?
- Can I Claim Interest Payments on Refinanced Student Loans?
- Should I Make Only Minimum Interest Payments So I Can Prolong My Eligibility?
- Which States Have a Student Loan Tax Credit?
What is the Student Loan Interest Deduction?
A tax deduction is something that lowers your taxable income, which therefore reduces your overall tax liability. The student loan interest tax deduction is a deduction you can claim on your tax return without itemizing.
The Internal Revenue Service (IRS) caps the student loan tax deduction at $2,500. We created this student loan interest tax deduction calculator to help you estimate tax reductions in specific scenarios. In short, the amount you can deduct from your taxes depends on your modified adjusted gross income (MAGI).
Who is Eligible for the Student Loan Tax Deduction?
Eligibility for the student loan tax deduction is based on several factors, including:
- You must have attended a higher institution that is eligible for Title IV federal student aid, which includes most colleges and universities in the nation.
- You must have attended college at least half-time.
- You must be legally obligated to repay the loan. In other words, you (and/or your spouse, if applicable) are the signatories; if your parents make payments on loans in your name, they are ineligible to claim the deduction. If they’re a cosigner on the loan, they can claim it.
- The interest must have already been paid towards a student loan from a qualified lender. (Accrued interest you haven’t started making payments on yet does not count.)
- The interest can’t be paid to any non-qualified sources, such as family members or an employer who loans you money to pay for college.
- You can’t be claimed as a dependent on anyone else’s tax return.
Income restrictions also apply. Those with a MAGI of less than $65,000 can qualify for the full $2,500 tax deduction. The amount of your student loan interest deduction is phased out if your MAGI falls between $65,000 and $80,000 (or $135,000 and $165,000 if you’re married filing jointly).
If your MAGI is $80,000 or more ($165,000 or more if you file a joint return), or you file a separate married return, you lose your ability to deduct any student loan interest at all. Whether or not you’re married, you can only claim a single tax deduction totaling $2,500 — not $5,000.
What is the 1098-E Student Loan Tax Form?
Form 1098-E is a special tax document from the IRS specifically designed for reporting student loan interest. 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.
Although getting Form 1098-E in the mail is an eligibility indicator, it does not actually mean you are officially eligible for the tax deduction. To receive the form, you must have paid at least $600 in interest (remember, the maximum deduction is $2,500).
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 of your outstanding loans.
Can I Claim Interest Payments on Refinanced Student Loans?
There is a common misconception that once you refinance student loans with a private lender, you can no longer claim student loan interest payments on your taxes. However, this isn’t true — you can deduct interest payments made toward any type of student loans, both 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 eligibility and income requirements as outlined above, you are good to go. If you are considering refinancing your federal student loans, don’t fall into the trap of believing you won’t be eligible for the deduction.
Should I Make Only Minimum Interest Payments So I Can Prolong My Eligibility?
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 — especially when there are better ways to lower your tax liability, like contributing to retirement plans or saving for a child’s college education.
You would save more money paying off student loans fast. The longer you have your loans, the more interest that accrues and the more you will end up repaying over the life of the loan.
In addition, the student loan tax deduction won’t save you that much money. Unlike tax credits, which reduce your tax bill dollar for dollar, deductions reduce how much of your income is subject to taxes. 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 you would only have to pay $7,500 in taxes if you’re initially required to pay $10,000.
States With a Student Loan Tax Credit
Some states go above and beyond for their student loan borrowers by providing a student loan interest credit.
To understand how valuable this is, you have to understand the difference between a tax deduction and a tax credit.
The actual cash value to you of a tax deduction is the amount of the deduction multiplied by your marginal tax rate. So, if your marginal tax rate is 10% and you receive a $500 deduction, the actual cash value to you of that credit is $50.
But the actual cash value to you of a tax credit is the amount of the credit itself: if you receive a $500 tax credit, the actual cash value to you of that credit is $500!
While rare, there are a few states that offer a student loan tax credit rather than a student loan deduction. Below we go over these states and the rules surrounding their credit.
Maine Educational Opportunity Credit
Maine offers a credit for student loan payments made by residents during the year.
The maximum credit is based on the kind of degree you obtained, and it changes every year. The amounts for 2019 have not yet been released, but below are the maximum credit amounts by degree type for the 2018 tax year:
- Associate’s degree: maximum credit amount is $888
- Bachelor’s degree: maximum credit amount is $4,524
- Graduate degree: maximum credit amount is $3,936
The credit is generally nonrefundable, meaning that you can only take a credit up to your tax liability; you do not get a refund for any credit amount beyond your tax liability. However, for borrowers who obtained a bachelor’s degree in a STEM field, the credit is refundable.
Maryland Student Loan Debt Relief Tax Credit
Marylanders who left college with at least $20,000 in student loan debt and currently have at least $5,000 in student loan debt may be eligible for a state tax credit. Note that these $20,000 and $5,000 amounts include accrued interest.
The credit amount will be different for every student, and unlike many other states, you must apply for the credit, and not every applicant will be awarded the credit. Interested student loan borrowers have until September 15th of each year to apply for the credit with the Maryland Higher Education Commission.
Minnesota Student Loan Credit
Minnesota offers a nonrefundable credit of up to $500 per resident who made payments on their own student loans during the year (so paying off someone else’s student loans doesn’t count).
The state instructs those taking the credit to save canceled checks and keep a log of student loan payments made. Of course, in this modern era of web payments, this can be as easy as going into your student loan servicer’s dashboard and printing out your loan activity for the year.
As mentioned, the credit is per resident, so if both you and your spouse make student loan payments during the year, you may qualify for a combined $1,000 return on your joint Minnesota return.
Rhode Island Wavemaker Fellowship
Similar to the Maryland program, the Rhode Island Wavemaker Fellowship is application-based.
Applicants must work in Rhode Island in a STEM field and the application committee favors applicants with a strong likelihood to remain in Rhode Island and be a productive member of its economy longterm.
Similar to the Maine program, the maximum Wavemaker Fellowship award varies by degree obtained:
- Associate’s degree: maximum award is $1,000
- Bachelor’s degree: maximum award is $4,000
- Master’s degree: maximum award is $6,000
Whether or not the government is the source of our nation’s student loan problem, it is nice to see it is trying to help borrowers in some form. Although the student loan interest deduction won’t significantly reduce the overall cost of borrowing, every bit helps.
If you are currently in the repayment phase, there is no reason not to take advantage of the deduction so long as you’re eligible. Also, remember you are still eligible for this benefit even if you refinance your student loans or take advantage of income-driven repayment plans.
You can learn more about how student loans affect taxes in our Student Loans & Taxes Guide.
Logan Allec—a CPA and owner of the personal finance blog Money Done Right—contributed to this article.
Author: Jeff Gitlen