All About the Student Loan Interest Tax Deduction
- November 21, 2017
- Posted by: Mike Brown
- Category: Student Loans
While the tax plan debate rages atop Capitol Hill, the majority of student loan borrowers have no idea how they might be impacted.
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.
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.
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!
Survey from 11/27/17
In the past couple of weeks, no story has dominated the news cycle quite like the debate happening in Washington D.C. regarding tax reform.
And, rightfully so.
The last time the tax code was rewritten was more than 30 years ago, when Ronald Reagan was president. Not only is tax reform a rare occurrence, but it is something that will impact every American, no matter their financial standing.
If the most sweeping tax overhaul in more than three decades is signed into law, one group of people will particularly feel the ramifications: student loan borrowers.
At the time of this writing, the House of Representatives already passed the tax bill, which includes removing the student loan interest tax deduction that borrowers have long been able to claim. The Senate, likely to vote after Thanksgiving, must pass their own modified version, and it remains unclear if they will keep the student loan interest tax deduction revision in their bill or not.
Are student loan borrowers aware of the implications that the tax reform might have on them? LendEDU polled 1,000 borrowers currently in repayment to find out.
Full Survey Results
1. "Are you aware of the changes that the proposed tax plan may have on your ability to claim the student loan interest deduction tax credit?"
a. 44.60% of respondents answered "yes."
b. 55.40% of respondents answered "no."
2. "Would you support the government putting the extra money from eliminating the student loan interest tax deduction towards federal financial aid programs such as grants?"
a. 53.50% of respondents answered "Yes, that is a better use of the money."
b. 24.40% of respondents answered "No, I would rather have the money in my pocket."
c. 22.10% of respondents answered "unsure."
3. "Have you claimed the student loan interest tax deduction in the past?"
a. 46% of respondents answered "yes."
b. 54% of respondents answered "no."
4. "When you received the money back from the student loan interest tax deduction, what did you spend that money on?" (note: asked only to those who answered "yes" to the previous question)
a. 13.23% of respondents answered "Invested it in the market."
b. 34.92% of respondents answered "Saved it."
c. 35.57% of respondents answered "Put it right back towards my student loan debt."
d. 4.34% of respondents answered "entertainment."
e. 11.93% of respondents answered "other."
The Majority of Borrowers Unaware They May Lose Ability to Claim Student Loan Interest Tax Deduction
As it stands today, student loan borrowers are able to deduct up to $2,500 of student loan interest paid in a given year. There is a limit to this deduction, and an individual's adjusted gross income cannot exceed more than $80,000, or $160,000 for married couples filing jointly.
If the House's proposed tax reform is signed into law via presidential signature, the student loan interest deduction will no longer be able to be claimed. How the government would spend that money remains to be seen.
Are student loan borrowers aware of this? We asked 1,000 borrowers currently in repayment the following question: "Are you aware of the changes that the proposed tax plan may have on your ability to claim the student loan interest deduction tax credit?"
The slight majority of student loan borrowers, 55.40%, stated that they were unaware of any such tax proposal that would impact their ability to claim the student loan interest deduction.
Meanwhile, 44.60 percent, of respondents currently in repayment answered that they were aware of the ramifications that may stem from the proposed tax reform.
Borrowers Would Support Eliminating the Interest Rate Deduction IF the Money Is Put Back Into Financial Aid Programs
Earlier this month, an article written on MarketWatch discussed the idea of the government using the money saved from eliminating the student loan interest deduction on financial aid programs that would bring down the cost of education, such as grants.
Its an interesting idea that merits discussion. Borrowers might not get the sense of instant gratification that comes with getting up to $2,500 back, but they could end up spending less money on education in the long run.
To gauge their thoughts on the proposal, we asked the following to 1,000 borrowers in repayment: "Would you support the government putting the extra money from eliminating the student loan interest tax deduction towards federal financial aid programs such as grants?
As the above table displays, student borrowers currently in repayment strongly support the idea of putting the money the government saves from eliminating the student loan interest deduction towards financial aid programs that would hypothetically bring down the cost of education. 53.50 percent of respondents supported this theoretical measure, while 24.40 percent would rather have the money in their pocket, and 22.10 percent were unsure.
Majority of Borrowers Have Never Claimed the Interest Deduction in the Past
The student loan interest deduction is a great way for cash-strapped student loan borrowers to reclaim up to $2,500, but have they been taking advantage of it in the past?
We asked the following to find out: "Have you claimed the student loan interest tax deduction in the past?"
54 percent of student loan borrowers currently in repayment have never once claimed the student loan interest deduction, while 46 percent have.
We asked those who have claimed the interest deduction in the past the following question: "When you received the money back from the student loan interest tax deduction, what did you spend that money on?"
35.57 percent, or the plurality, of student loan borrowers that have claimed the interest deduction in the past stated that they put the money right back towards their educational debt. 34.92 percent of borrowers have saved the money claimed from the student loan interest deduction, while 13.23 percent have invested that money back in the market.
Another 11.93 percent of this sub-section used the money for a reason not listed, and 4.34 percent of borrowers used it for "entertainment."
If there was one argument against the premise that the cost of education would go down if the government used the money from the student loan interest deduction to fund financial aid programs, it would be that consumers would be better at spending their money than the government would be.
If our results hold true for all student loan borrowers that have claimed the interest deduction in the past, than a vast majority of them would either be putting the money right back towards their student loan debt, saving it, or investing it in the market. It could be argued that any three of those methods would be more efficient at bringing down that respective borrower's cost of education when compared to the government using that money on broad financial aid programs.
Contrarily, since the majority of borrowers in repayment have never claimed the student loan interest deduction to begin with, maybe borrowers as a whole group would be better off letting the government handle all of the saved money under one program to lower the cost of education for a wider net of student debtors.
All data that is displayed in this report stems from a poll commissioned by LendEDU and conducted online by online polling company Pollfish. In total, 1,000 student loan borrowers currently in repayment were polled. Respondents were filtered via screener question to ensure they were student debtors that were currently going through repayment. Only one answer from the screener question was permissible. The poll ran over a three-day span from November 10, 2017 to November 12, 2017. All respondents were asked to answer each question truthfully and to the best of their ability.
Image Copyright © Thomas Hawk