The Institute for College Access and Success reports that 70 percent of 2012 college graduates left school with outstanding student loans. The level of debt for these graduates nationwide averages $29,400. Repaying these loans is a challenge in an economy with high unemployment. Those that do find work often are underemployed with less than full-time hours and low wages.
The U.S. tax code does provide some relief for graduates in the form of student loan interest deductions. While interest on loans other than home mortgages is usually not deductable, the tax code provides a special deduction for money borrowed to finance higher (post-secondary) education.
The difference between a tax deduction and a tax credit
Tax deductions lower the amount of income that is subject to tax. Tax credits are applied against the amount of tax owed. While graduates may be eligible for tax credits for some education expenses, student loan interest is a deduction that will lower a taxpayer’s taxable income.
Who qualifies for the student loan interest deduction
Taxpayers with modified adjusted gross incomes less than $75,000 ($150,000 for married filing jointly taxpayers) who paid interest on a qualified student loan for themselves, spouses or dependents may take this deduction.
The taxpayer must be the individual making the loan payments and be responsible for repayment in order to take the deduction. For example, if the loan is in the student’s name, and a parent is making the loan payments, no deduction is allowed.
Additionally, a taxpayer who qualifies as a dependent on another’s tax return, whether or not the exemption is claimed, may not take the deduction. No deduction is allowed for taxpayers filing as married filing separate.
Which loans qualify
A qualified student loan may be a federal or a private loan used to pay for:
- Tuition and fees
- Room and board
- Books, supplies and equipment
- Other necessary expenses (such as transportation)
The amount used for room and board must not exceed the actual amount charged for student housing by the educational institution or the housing allowance calculated by the institution for financial aid purposes.
How to take the deduction
The student loan interest deduction is an adjustment to income reported on line 33 of IRS form 1040. Taxpayers may take this deduction without filing a Schedule A, Itemized Deductions form. Borrowers will receive a form 1098-E from their lending institution in January showing the total amount of interest paid in the prior year. Up to $2,500 may be deducted as an adjustment to income.