Under Internal Revenue Service (IRS) rules, taxpayers with active student loans are entitled to special deductions. These deductions apply to the interest paid on the loan in a given year. They help borrowers reduce the lifetime cost of their student loans by putting hundreds of dollars back into their pockets. However, the rules and the process for claiming these deductions are a tad complicated. This guide will explain the student loan interest deduction rules in detail.
Student Loans and COVID-19
First off, a word to borrowers holding federal loans backed by the Department of Education (ED). In 2020, the ED announced an emergency program designed to help federal student loan borrowers ease the financial sting of COVID-19. It included three major relief measures for people with active student loans:
- All required loan payments were temporarily suspended.
- All loan interest rates were reduced to 0%.
- Collection agency actions on loans in default were halted.
The ED announced a final extension of the COVID-19 relief program on August 6, 2021. Loan payments, interest charges, and collections action on loans in default will resume as normal on February 1, 2022.
What Are the IRS Rules on Student Loan Interest Deductions?
Student loan interest deductions are explained in IRS tax topic number 456. The rules allow for up to $2,500 per year in tax deductions on student loan interest payments. To qualify, taxpayers must meet several conditions:
- The interest must be paid on a qualified student loan.
- The interest must have been paid during the current tax year.
- You were legally obligated to pay the interest
Thus, things will be a little complicated for the 2020 and 2021 tax years for borrowers of ED-backed loans. Thanks to the CARES Act, borrowers were temporarily relieved of their legal obligations to make loan or interest payments. However, this does not apply to people holding private student loans and loans not owned by the ED.
What Is A Tax Deduction?
Tax deductions apply to your taxable income. You can use them to reduce the amount of income subject to federal taxation. Let’s say you had $40,000 in taxable income and you paid $2,000 in interest on qualified student loans. After applying the $2,000 deduction, your taxable income would be $38,000.
People often confuse tax deductions with tax credits. Tax credits are not subtracted from your taxable income. Rather, they come off your tax liability — the amount of money you owe in taxes on your annual income. This IRS resource explains the difference in further detail.
What Other Rules Apply to Student Loan Interest Deductions?
The IRS applies several other eligibility rules to taxpayers seeking to deduct student loan interest from their tax deductions. First, you cannot claim the deduction if you are married but filing separately from your spouse. If you are jointly filing with your spouse, neither of you can appear as dependents on another person’s tax return. Finally, your household modified adjusted gross income (MAGI) must fall below specified cutoffs. These change each year, but for 2021 they run as follows:
- $70,000 to $85,000 for single people filing individually.
- $140,000 to $170,000 for couples filing jointly.
Individual incomes above $70,000 but less than $85,000 still qualify for these deductions, but have reduced maximums. The same applies to couples with MAGIs above $140,000 but below $170,000. You can also claim deductions on mandatory and voluntary payments, up to the maximum that applies to your income level.
If your income falls between these ranges, you lose the ability to claim the student loan interest tax deduction proportionally. For example, if you paid at least $2,500 in qualifying student loan interest but earned $75,000 as a single filer during the tax year, you could only claim two-thirds of the $2,500 as a tax deduction, or about $1,667.
Likewise, if you earned $160,000 as a couple filing a joint return, you could only claim one-third of the $2,500 allowable deduction, or about $833. Married couples who both have student loans don’t receive double the deduction, or up to $5,000 per tax year.
Which IRS Forms Do You Need?
The IRS forms you’ll need to claim your deduction depend how much you paid in student loan interest. If you paid less than $600, you likely won’t get an IRS form from your lender. However, you can still claim the tax deduction. If you need help with this, speak to your student loan servicer or a loan specialist at your school.
If you paid more than $600, you will need IRS Form 1090-E. You’ll also need to submit IRS Form 1040 or 1040-SR.
IRS Form 1090-E
IRS Form 1090-E is also known as a Student Loan Interest Statement. If you pay more than $600 in interest on your student loan, you should receive one automatically. Your lender or loan servicer will also submit an identical copy directly to the IRS.
The Student Loan Interest Statement will state the exact amount of money you paid in loan interest during the year. You must cite the same figure on your tax return (IRS Form 1040/1040-SR).
IRS Form 1040/1040-SR
IRS Form 1040 is a U.S. Individual Income Tax Return statement. Its counterpart, Form 1040-A, was used until 2018. Form 1040-A has since been replaced by Form 1040-SR, also known as the U.S. Tax Return for Seniors.
Most people claiming tax deductions for student loan interest will use Form 1040. However, people age 65 and up may be eligible to claim these benefits if they:
- Have an active student loan themselves.
- Pay student loan interest on behalf of a dependent.
For assistance completing your individual income tax return, refer to these IRS instruction guides for the relevant form(s).
What Other Tax Benefits Apply to Education?
If you don’t qualify to deduct student loan interest from your tax return, you might be eligible for other programs. The U.S. government offers several other tax breaks and benefits for higher education.
The most common examples include the Lifetime Learning Credit (LLC) and the American Opportunity Tax Credit (AOTC). You may also get a tax break if you funded your education through a 529 plan.
Lifetime Learning Credit (LLC)
The Lifetime Learning Credit is an IRS program that applies to tuition and other eligible education expenses. You can claim it for undergraduate and graduate degree programs, and for professional degree programs.
LLC benefits max out at $2,000 per tax return. You can claim the credit for any number of years as long as you qualify. However, you or your dependent must be actively enrolled in an eligible education program to get the credit.
American Opportunity Tax Credit (AOTC)
Students in the first four years of a qualified higher education program are eligible for the AOTC. Like the LLC, AOTC rules limit the credit to students actively enrolled in school. You cannot claim it after you’ve graduated.
The AOTC provides up to $2,500 in annual tax relief. One major advantage of this program is that you can receive cash benefits. If the AOTC reduces your income tax to zero, you can get a refund for up to 40% of the remaining credit.
Specialized 529 plans come in two types: education savings plans and prepaid tuition plans. Both types function in similar ways, as they shield deposited savings from taxation. Those funds can later be used to pay for tuition costs or other qualified educational expenses.
These plans get their name from Section 529 of the IRS code, which authorizes them. At least one type of 529 plan is available in every U.S. state and the District of Columbia.
The Bottom Line
Student loan payments are a bummer, but interest payment deductions from your income tax can ease their sting a bit. If you qualify, you can deduct up to $2,500 a year from your taxable income. This can translate into tax savings in the hundreds of dollars, depending on your tax bracket.
The rules surrounding these tax deductions are complex, with many limitations and exceptions. If you need help navigating them, enlist the services of a licensed accountant or qualified tax professional.