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Student Loan Tax Deduction Opportunities for Borrowers

student loan tax deduction

Debtors usually try to find ways to decrease or eliminate their obligations. While there exist programs like student loan forgiveness, cancellation, or discharge, they can be hard to access. What borrowers ignore is that they can even get benefits through tax filing. Currency, student loan tax deduction is possible in several ways. Tax deduction for interest or two different types of tax credits can be good examples of such benefits. As a result of these benefits, the borrower can compensate for some expenses by paying fewer taxes. This guide will explore the available options and try to help borrowers take advantage of them.

Before discussing the opportunities borrowers have for student loan interest and taxes, they should understand the main difference between these options. Student loan interest deductions decrease the taxable income. Hence, the borrower pays less tax. On the other, tax credits reduce the tax amount directly. In all cases, these benefits are worth considering to have some compensation for educational costs. 

Student Loan Tax Deduction

In general, borrowers’ interest payments are not deductible for tax returns. There can be some exceptions depending on the student loan type, such as some mortgage interests. Another exception is that if the borrower receives Modified Adjusted Gross Income less than $85000, he/she can get a tax deduction for the student loan interest. Modified Adjusted Gross Income is mostly the Adjusted Gross Income found in the tax return. However, this amount is before making any interest deductions. Student loan interest deduction on tax can be a maximum of $2500. 

One should keep in mind that student loan payment tax deduction does not decrease the tax amount directly. Instead, this opportunity reduces taxable income. 

Eligibility Requirements

The eligibility requirements for this student loan tax deduction of interests are extensive. They determine the qualifying student, school, loan, expenses, etc.

Qualifying Loan

First, the student should have an eligible loan for this program. This loan should be taken for educational purposes, to cover its costs, for the individuals themselves, their spouses, or dependents. Dependents can be children or relatives. The loan proceeds should cover the expenses paid or incurred in a reasonable time. Reasonable time periods will be explained in subsequent sections. Lastly, education should be provided for an academic period. The academic period can be semester, trimester, summer school, etc., in a qualifying school. Usually, schools determine academic periods. 

Keep in mind that student loan payment tax deductions do not apply to cases when they borrow money from related people or an employer program. Related people can be spouses, siblings, half brother-sisters, ancestors, children, trusts, etc. 

Reasonable Time Period

Two main requirements define a reasonable time. First, if the expenses are made in an academic period, it is considered a reasonable period. Additionally, the borrowed money should be disbursed 90 days before the academic period starts, and it ends 90 days after the academic period completion. 

Eligible Student

Qualifying students, whether they are the individuals who file the tax, their spouses, or dependents, should be studying at least half-time. Their programs should provide a reliable credential, such as a degree, certificate, etc. 

Besides, the school they study should also be eligible. Almost all accredited schools qualify for this student loan tax deduction of interest. However, more detailed requirements demand the school to have access to federal aid. The schools can be public, private, non-profit, summer schools, etc. Additionally, if the student is in an institution conducting internships, he/she will qualify. 

Qualifying Expenses

In the context of student loan tax deduction, the educational expense is the total cost of study. It means such expenses include tuition fees, accommodation, books, supplies, equipment, and transportation. Here, accommodation covers room and board costs determined by the school. This amount is usually shown in the cost of attendance. When the accommodation cost is higher than this amount, the student loan tax deduction will only cover if the accommodation is owned or operated by the school. 

Adjustments of Expenses

If a borrower receives additional tax-free items, they should be deducted from the qualifying expenses. Such tax-free benefits can be employers’ educational assistance, non-taxable earnings distribution from Coverdell Education Savings Account, Qualified Tuition Programs, or other assistance programs. 

What is Included in Interest?

Student loan interest is the interest paid during the year for the loan. However, in this context, interest has an even wider context.

Firstly, origination fees are usually included in this interest. It is a one-time payment to the lender when getting the loan. If this payment is for the use of money, it is added to the original loan amount. Hence, the interest is calculated from the origination fees, too. However, when the fee is for property or service, it is not covered. 

Second, capitalized interests are also considered. Capitalized interest is the non-paid interest which is added to the outstanding student debt balance. For the student loan tax deduction for interest purposes, capitalized payments are treated as interests. 

Third, if the borrower uses the credit card funds to cover educational costs, this program will cover its interests. 

Lastly, when students utilize refinancing or debt consolidation strategies to combine their loans, the program includes the new interest, too.

How much is the Benefit? 

The student loan tax deduction in this program is either $2500 or the interest paid during a year. When calculating the deduction, the lower amount should be considered. However, the student loan interest and taxes also depend on the Modified Adjusted Gross Income. If the MAGI is higher than a certain amount, the phase-out will be applied.

Phase-Out of the Deduction

When borrowers earn less than $70000, or $140000 in case of joint filing, their deduction benefit is calculated in the standard way mentioned above. However, between the range $70000-$85000 in single filing and $140000-$170000 in married filing jointly, the phase-out will start. It means the deduction amount will be decreased gradually. It is no surprise that a MAGI level of more than $85000 or $170000 will not qualify for this student loan payment tax deduction. 

For most borrowers, MAGI is just AGI shown on the tax return before deduction loan interest. If the borrowers file Form 1040-Sr or 1040, then the MaGI equals to AGI, if some items like foreign earning exclusion, foreign housing exclusion/deduction, or excluded income by bona fide residents etc., are added back.

How much is the Benefit of Phase-Out?

Calculating the reduced student loan tax deduction for interests is fairly easy. However, one can use a student loan tax deduction calculator to estimate the amount. Such estimation platforms exist online. 

Imagine an individual with MAGI of $160000. The total paid interest is $800. Then you can estimate the deduction:

  1. Multiply the student loan interest paid with the difference between the current MAGI ($160000) and the lower limit of the phase-out range (in our case, it is a joint filing, so the lower limit is $140000).
  2. Divide this amount by the difference in the phase-out range( in a joint filing, the difference is $30000, and for a single filing, it is $15000).
  3. Subtract the resulting amount from the original deduction benefit without phase-out. 

Summarized Student Loan Interest Tax Deduction

In this guide, we tried to cover as many points as possible to explain if the student loans’ tax-deductible payments and how they work. However, there are still many technical points which should be further elaborated. You can get more information by contacting Student Loans Resolved or checking the publications on the Internal Revenue Service official website. Here is the summarized student loan tax deduction for interests:

  • One can get a maximum $2500 benefit in the form of a taxable income deduction with this program.
  • Loans that qualify for this opportunity must be taken for eligible education costs, and it cannot be sourced from a relative or an employer plan.
  • Eligible students are the individuals themselves, their spouses, or dependents. These students should be studying at least half-time to get a degree or other credentials in qualifying schools.
  • The maximum limit of Modified Adjusted Gross Income is $85000 for single filing and $170000 for married filing jointly. 

Tax credits are another type of student loan tax deduction. Such credits help to compensate for the educational costs by decreasing the income tax. Currently, there exist two tax credit programs: American Opportunity Credit and Lifetime Learning Credit. 

American Opportunity Credit

american opportunity credit

This student loan tax deduction program brings up to $2500 benefit in reduced income tax. Credit means that the final tax will be decreased while student loan interest deduction reduces the taxable income. One of the greatest features of this program is that it is refundable. 40% of the credit can be refunded to the individual if the credit received is more than the tax. The credit amount depends on the income level, while the non-refundable portion depends on the tax. 

Students should keep in mind that they cannot claim both tax credit options for a single year. It means if you have qualifying education expenses for American Opportunity Credit, you cannot use the same costs for taking advantage of Lifetime Learning Credit. However, the case can be different if the individual makes education expenses for two students. In this case, the person can choose one program for one of the students and another program for the other student in the same year.

Another critical point is that an individual can be banned from claiming this credit. In case of intentionally disregarding the rules or claiming the credit while being ineligible, the students should not file the claim for 2 years. However, if the decision is that the student engaged in fraudulent activity, then he/she should not claim this credit for as long as 10 years. 

Eligibility Criteria for Students

This student loan tax deduction program has an extensive eligibility requirement. As ineligibility can result in a ban for two years, it is essential to get familiar with all conditions. For any questions, you can contact Student Loans Resolved or check the official website of Internal Revenue Services.

All eligibility criteria can be simplified in the following three points. However, these points are general, and each also has a detailed description in the subsequent sections: 

  1. Pay qualifying educational expenses
  2. Pay these expenses for qualifying student
  3. This student is either you, your spouse, or dependent on your tax return.

Qualifying Expenses

This student loan tax deduction opportunity covers educational costs, including tuition, supplies, equipment, etc. In general, costs incurred for enrolling and attending an eligible school can be recovered by tax credits. Here, eligible schools can be public, non-profit, private colleges, or other postsecondary institutions. Such institutions should be eligible to get federal student aid from the Education Department. The good news is that almost all accredited schools satisfy these requirements. 

Even some schools outside the US can qualify for student loan tax deduction. If students are not sure about the eligibility of their schools, they can ask the school officials. 

For supplies, books, or equipment, the place of purchase, whether bought from the school or not, does not matter. Expenses like room and boarding, transportation, insurance, medical, and other similar living costs do not qualify for this tax credit program.

Qualifying Students

For American Opportunity Credit, a student should still be studying in postsecondary education. For at least one period in 2019, he/she should attend for half-time. If the students were convicted due to possession or distribution of drugs, they would not benefit from this student loan tax deduction program. Lastly, the student should have claimed credits in this program for 4 earlier years. 

How Much Benefit is Received?

In general, this student loan tax deduction opportunity covers the first $2000 expenses fully, and the next $2000 by 25%. It means, if you paid $4000 expenses, you could claim $2500 income tax credit for each eligible student. However, this amount can change depending on the Modified Adjusted Gross Income(MAGI). As this income level increases, the general phase-out of the tax credit process will start. 

If you receive Modified Adjusted Gross Income less than $80000 or $160000 for a joint return, there is no need to worry about phase-out. The amount of this student loan tax deduction program will be calculated as explained before. However, between $80000- $90000 or $160000-$180000, the tax credit will be phased-out. You can still calculate how much is the reduced tax credit in a few steps.

Imagine a joint return filing when the Modified Adjusted Gross Income is $170000. Previously, you paid $5000 expenses, which means you are eligible to receive $2500. However, as the MAGI is between $160000-$180000, a benefit reduction will be applied. In this case:

  1. Multiply $2500 with the difference between the upper limit($180000) and MAGI’s current level ($170000).
  2. Divide this number by the difference between phase-out limits; in our case, this difference is $20000($180000-$160000) for joint filing.
  3. The resulting amount is the reduced tax credit. 

Alternatively, some online platforms provide a student loan tax deduction calculator to estimate this amount. 

Summary of American Opportunity Credit

We understand that this program’s details can be complex, so we summarized American Opportunity Credit in this section. However, it is always advisable to read and get familiar with all the program’s tiny elements before filing. In this guide, we tried to cover many details, but visiting the Internal Revenue Service’s official website or contacting a third-party to get more information is strongly encouraged. 

  • One can get a maximum of $2500 credit per student in income tax.
  • MAGI for separate/single filing is $90000 and for joint filing is $180000.
  • 40% of the credit can be refunded.
  • A student can only claim credit for 4 years.
  • A program that students study should be eligible and provide a credential, like a degree.
  • At least half-time study is necessary.
  • Possession or distribution of drugs is not acceptable.
  • Education expenses include tuition fees, supplies, course materials, regardless of where they were bought.
  • The TIN must be issued, and EIN (Employer Identification Number) should be provided.

Lifetime Learning Credit 

Another tax credit program that compensates educational costs is the Lifetime Learning Credit. It covers $2000 worth of income tax for eligible education costs paid for qualifying students. There is no limitation on the number of years an individual can claim the credit in this program. Besides, it is a non-refundable opportunity. It means the educational expenses can only decrease the tax amount to zero. Hence, even if there is an excess, the amount will not be returned to the payer. Again, the credit amount depends on the income and tax levels. 

Students should keep in mind that they cannot benefit from both tax credits programs for the same year. They should choose either the American Opportunity Credit or Lifetime Learning Credit. If they qualify both, it is better to claim American Opportunity Credit due to its greater benefit. As mentioned before, if the individual makes expenses for two dependent students, he/she can choose different programs per student.

Eligibility Requirements

This student loan tax deduction opportunity has the same general rules as the American Opportunity Credit. These rules qualify expenses, eligible schools, and loan payments for the eligible student, spouse, or dependent. However, there exist changes when we read these rules in detail. 

Qualifying Expenses

If an individual pays educational expenses for himself/herself, spouse, or a dependent, he/she can get the tax credit. This student loan tax credit opportunity covers expenses like books, supplies, equipment, tuition fees for an academic period. The academic period can be a semester, trimester, summer school, or any period defined by the school. If a borrower took the loan to pay the expenses, he/she could claim the credit on these payments. Again, insurance, medical, accommodation, transportation, or other personal costs are not covered by this student loan tax deduction program.

Besides, students who take noncredit courses like sports, hobbies, or games cannot compensate for their costs by claiming the tax credit. Only if these courses are part of the degree program and are necessary to improve students’ job skills will they be eligible for the tax credit. 

Eligible schools have the same conditions as the American Opportunity Credit. 

Who can Claim This Benefit?

People who have dependents and pay their educational expenses can claim tax credit for such costs. Alternatively, the dependent himself/herself can claim the credit. However, both of them cannot claim the Lifetime Learning Credit at the same time. Such people should keep in mind that they should show these dependents on their tax returns to claim credit for a dependent’s costs. It means they should list the dependents’ names on the necessary parts of the 1040 or 1040-SR platform.

Amount of Benefit

This tax credit program’s benefit is calculated by considering 20% of the first $10000 qualified expense. Hence, the individuals can receive a maximum $2000 tax credit. However, this amount depends on the income level. 

If you earn Modified Adjusted Gross Income less than $58000 or $116000 in case of joint filing, the benefit amount is as mentioned before. However, between $58000 and $68000, for a single filing, the phase-out will happen. It means the tax credit amount will decrease. This Modified Adjusted Gross Income level is between $116000 and $136000 for joint return filing. 

It should also be mentioned that one can figure the Modified Adjusted Gross Income in the federal income tax return. In 1040 or 1040-SR forms, this number will appear in the form of Adjusted Gross Income. In this case, one can modify this amount by adding elements like foreign housing exclusion/deduction, foreign income exclusion etc.

How to Find the Reduced Tax Credit?

student loan tax deduction

One can calculate the amount of phase-out benefit in a few simple steps. Alternatively, it is possible to find a student loan tax deduction calculator on an online platform. 

Imagine an individual with $120000 MAGI, which is in the range of joint filing phase-out. He/she paid $6000 as an educational expense; hence the 20% will be $1200 originally. To calculate the reduced tax credit: 

  1. Multiply original tax credit ($1200) with the difference between the upper limit of phase-out filing($136000 in case of joint filing) and the current MAGI level ($120000).
  2. Divide this amount by the difference between the phase-out range. This amount is $20000 for joint filing ($136000-$116000).
  3. The resulting amount ($960) is the reduced tax credit for student loan tax deduction.  

Summarized Lifetime Learning Credit

Here is the summary of the Lifetime Learning Credit program details. However, these elements are general, and they should be further researched. You can get more related information on the Internal Revenue Service platform or contact us for expert advice.

  • A student can get a maximum of $2000 credit per filing.
  • The limit on Modified Adjusted Gross Income is $68000 for single and $136000 for joint filing.
  • This student loan tax deduction program is non-refundable.
  • A student can apply for an unlimited number of years.
  • Educational schools do not have to be providing a degree or other credential.
  • Prior drug convictions do not influence eligibility negatively.
  • Educational expenses for enrollment and attendance, including books, supplies are included. 

Differences between the American Opportunity and Lifetime Learning Credit

Though both options provide credits from income tax for education expenses, they have different features. First, there are a limited number of years for a student to claim American Opportunity Credit, which is 4 years. However, there is no such limitation in the Lifetime Learning Credit as students can claim credit as many times they want. Another difference is that it is possible to get a 40% refund with the American Opportunity program, while Lifetime Learning Credit is non-refundable. Additionally, the American Opportunity Credit’s maximum benefit is $2500, while this amount is $2000 for the other tax credit program.

Previously, we mentioned that the American Opportunity Credit does not benefit people with felony drug convictions. However, this factor does not influence eligibility negatively for Lifetime Learning Credit. Besides, Lifetime Learning Credit does not require the school to provide a degree, certification, or other credentials. 

If the student qualifies for both programs, it is advisable to choose the American Opportunity Credit because this option provides higher benefits. 

Final Words

While borrowers’ main focus is on federal student loan forgiveness programs to get rid of the debt, they tend to ignore the relative lower benefits such as tax deductions. Though the options do not eliminate the debt or reduce the outstanding balance, they bring some compensation for the educational costs, up to $2500. Hence, they are totally worth considering. This guide discussed three different types of tax deduction- student loan interest deduction, American Opportunity Credit, and Lifetime Learning Credit. Each of them brings pros and cons, as well as varying eligibility requirements. Therefore, borrowers should read the guide carefully and check the official website to find the most suitable option.

Although we tried to explain details clearly, readers can still have a challenging time understanding the information. The main reasons for the confusion are the extensive eligibility requirements of student loan tax deduction and many technical terms. Hence, we advise leaders to ask their questions from debt specialists, such as those Student Loans Resolved work with. In this way, our experts can guide the borrowers during the process and direct them to the right tax deduction option.