If you're like many people in the United States, you probably dread the weeks leading up to April 15. This is tax season, and unlike some other, more joyful seasons of the year, this one doesn't always bring glad tidings. For many people, it means scrambling to figure out tax code to complete and file tax returns with the Internal Revenue Service (IRS) in time for the April 15 deadline. The goal for you, apart from simply understanding how to fill out the seemingly indecipherable forms, is probably to figure out the amount you're legally obligated to shovel out to Uncle Sam.
However, because the tax code is so complicated, it can be tremendously difficult to find all of the tax burdens and benefits that apply to your situation. You might feel overwhelmed, but you aren't alone. In fact, studies estimate that more than half of Americans decide to use professional help with their taxes [source: Consumer Reports]. In 2010, even the IRS commissioner admitted to using a tax preparer because he found the tax code "complex" [source: C-SPAN].
But if you're also shouldering student loan payments on top of income taxes, there might be some good news. Since 1998, taxpayers who are paying back student loans have been able to take advantage of a handy tax deduction. It allows you to deduct the interest on student loans that you've paid during the tax year. You don't even have to itemize your deductions to take advantage of this perk -- it is considered merely an adjustment to the income you report for tax purposes [source: IRS].
However, it's not as simple as it looks at first glance -- alas, little in the tax code is, it seems. Some limits and caveats apply. For instance, the maximum deduction you can take is $2,500 -- even if you paid more than this in student loan interest [source: IRS]. In the next few pages, you'll learn more of the rules in addition to some little-known tips related to this tax perk.
You can find all the tax code relating to this benefit, including particular details on how to fill out the forms, from the IRS document, Publication 970. We're drawing the information for this article from Publication 970 for the tax year 2009.
Up first, find out whether you qualify to deduct your student loan interest on your income taxes.
Qualifications for the Student Loan Interest Deduction
So, how do you know whether you can take advantage of this deduction on your income taxes for student loan interest that was paid during the tax year?
First, you can claim the deduction if your filing status is "single" or "married, filing jointly," but you cannot claim it if you are filing as "married, filing separately." Also, if anyone else claims an exemption for you on his or her tax return, you won't be allowed to claim this deduction, but this is covered in more detail in the next section.
For qualification purposes, your income matters, too. Because the United States uses a progressive income tax, the more money you make, the heavier your tax burden. Similarly, the more money you make, the lower the amount of student loan interest is that you can deduct, and the deduction can even be obliterated if you make too much money to qualify for it at all. For example, if your MAGI for 2009 was more than $60,000 but less than $75,000 (or between $120,000 and $150,000, if filing jointly), the IRS will reduce the amount you're allowed to deduct. If your MAGI was more than $75,000 (or $150,000, if filing jointly), then you can say goodbye to this deduction altogether [source: IRS].
Unfortunately, you won't be able to use this deduction if your student loan was used to pay for anything other than qualified education expenses. The IRS gives a list of what kinds of things qualify as education expenses [source: IRS]. Obviously, tuition and student fees qualify, but so do room and board, books, equipment and necessary travel. If you open a revolving line of credit (a credit card) to pay solely for qualified education expenses, you can deduct the interest you pay on that as well. However, you cannot claim a credit for qualified education expenses paid with tax-free funds, such as veterans' education assistance [source: IRS].
The loan source might affect your qualification: If you got the loan from someone you are related to -- such as a parent, grandparent or spouse -- or through a qualified employer plan, you can't use this deduction. Student status also affects eligibility: You must have been enrolled at least half-time in an eligible education institution for this deduction to apply. Half-time standards are determined by the educational institution. If you're wondering whether your institution is eligible, call the administration office to ask.
Once you qualify, there are still a few more strings attached to this benefit. Up next, learn a few tips for dealing with them.
Tips and Caveats to the Student Loan Interest Deduction
In addition to qualifications for claiming this deduction, there are also a few other details you'll need to know when determining whether it applies to you.
On the last page you learned that, as a student, you can't claim this deduction if someone else claims you as a dependent on his or her tax return. However, if the student is your dependent, you might qualify to use the deduction. Unfortunately, if the dependent is the only one "legally obligated" to make payments, neither you nor the dependent may claim the deduction. Also, if anyone makes a loan payment on behalf of the student, the student can actually claim that as a deduction -- as long as the student is not claimed as a dependent on someone else's return. This is because the IRS treats this as a gift to the student, which is then paid toward the loan.
This complicated tax benefit will be somewhat simplified with the 1098-E form you should receive in the mail from the bank or lending institution where you send your loan payments. However, if your interest payments are small enough, the lending institution isn't required to send you an 1098-E, in which case you should use your loan statements to calculate your interest payments [source: IRS].
In some cases, the 1098-E will not show the correct amount you paid in interest (for tax purposes) because certain other things may apply toward deductible interest. If your loan was made before September 2004, for instance, the lending institution isn't required to list the loan origination fee on the 1098-E, which may qualify as interest (if it wasn't used toward property or services such as commitment fees or processing costs). If this is the case, or if you didn't receive a 1098-E, you can use a "reasonable method" to determine how much you paid toward the origination fee in a particular tax year -- Publication 970 gives a helpful example of how to do this [source: IRS].
Other things that count toward deductible interest include:
- Capitalized interest -- interest you haven't paid yet that is added to the principal of the loan payment
- Voluntary interest payments -- loan payments made before they are required
- Refinanced student loan interest -- such as consolidated or collapsed student loans (so long as you don't borrow more money in the process that isn't used toward qualified education expenses)
For the latest rules, details and examples refer to the IRS Publication 970 [source: IRS]. For more tax-related articles, browse the links on the next page.
Related HowStuffWorks Articles
- Consumer Reports. "How to save money on tax prep." Consumer Reports. March 2010 (last reviewed). (Mar. 17, 2010)http://www.consumerreports.org/cro/money/taxes/how-to-save-money-on-tax-prep/overview/index.htm
- C-SPAN. "Newsmakers with Douglas Shulman" C-SPAN (Video). Jan. 8, 2010. (Mar. 17, 2010)http://www.c-spanvideo.org/program/id/217806
- Internal Revenue Service. "Publication 970 (2009): 5. Student Loan Interest Deduction." Internal Revenue Service. (Mar. 17, 2010)http://www.irs.gov/publications/p970/ch05.html