Student Loan Interest Deduction: The IRS Wants You to Pay Down Your Student Debt

Student Loan Interest Deduction

Mitchell Fox is a Tax Nerd and the Co-Founder of GoodApril, a site that provides consumers with online tax planning and tax advice services and offers a free “Tax Checkup” to help you identify actions you can take to reduce your taxes. You can follow Mitch on Twitter at @mitchellwfox or @goodapriltax.

There are a lot of benefits to paying down your debt – psychological and financial alike – but one of the less known perks for paying down student loan debt is that it can help lower your taxes.

Here’s how it works

If your income is within the permitted range (see below), you can deduct up to $2,500 in student loan interest payments annually – it goes right onto line 33 of your form 1040. Unlike other tax breaks for education, your student loan may have been used not only for the basics (tuition, fees, books, etc), but also room and board (if you lived in university housing).

Like all tax rules there are a lot of caveats, but luckily, in this case they’re all pretty mundane:

  • The debt has to be in your name (the IRS says that “you [must be] legally obligated to pay interest”) – not in the name of your parents or someone else (they get to claim the deduction for themselves)
  • You (and your spouse, if married) cannot be claimed as a dependent on someone else’s return
  • You are not filing as “Married Filing Separately” (the IRS really doesn’t like that)
  • The loan had to be used solely to pay qualified higher education expenses, for a degree-awarding institution in which you were enrolled at least half-time
Single Post Advertisement
Ready to pay off debt faster?
We can help you make a free, personalized plan to pay off your debt as quickly as possible. Our free tool shows you which debt to pay off first. Try it now. Try it out

A Little Tax Planning Can Go a Long Way

Because the ability to deduct student loan interest payments is limited to people earning less than $75,000 per year (if single) or less than $155,000 (if married), higher-paid graduates have a narrow window within-which they can take advantage of the deduction: the year when they graduate.

Here’s what you should think about: will you have enough disposable income from that first job after graduating to be able to make some big interest payments? Perhaps all the way up to $2,500? If so, is your income going to be below the phaseout range (e.g. $60,000 for singles in 2012)? If yes, great. Make those payments!

If, however, your income is going to be between $60,000 and $75,000 (or close), then you can still benefit from the deduction, but you should consider some active tax planning. When you’re in the phaseout or close to the cutoff, reducing your taxable income not only lowers your tax bill for the year, but also enables you to take this deduction. So how do you do that? Contribute more to your 401K. If you don’t have one, make contributions to a Traditional IRA. Harvest some of the losses in your brokerage account – you know, that tech stock you lost money on but is still wallowing in your portfolio?

To help you understand this concept, consider Benny. He’s just finished his MBA and is going to earn about $70,000 between his summer internship, signing bonus, and first few months of work. Let’s say he’s able to pay off the full $2,500 of interest that he can deduct from his taxes. Because he’s earning $10,000 over the limit (at the 66% cut-off on the phaseout), he would only be able to deduct $850 of those payments. If, however, he contributed 10% to his 401K, and realized a $3,000 loss in his investment portfolio (sold his money-losing stock investments), he would be able to increase his deduction by $1,650.

Look ahead, not behind

If you didn’t make your student loan payments in 2012, you won’t be able to take the tax break this year. But don’t let that get you down! Start looking ahead to 2013, and take advantage of ReadyForZero’s tools to help you manage and pay down your student debt this year!

Student Loan Deduction Thresholds

Here are the income thresholds for the student loan interest deduction:

Filing Single and Head of Household:
$60,000 and below – full benefit
$60,000-$75,000 – partial benefit (take the amount of income over $60,000 as a percent of $15,000, and multiply it by $2,500 to determine your reduced benefit)

Married Filing Jointly:
$125,000 and below – full benefit
$125,000-$155,000 – partial benefit (take the amount of income over $125,000 as a percent of $30,000, and multiply it by $2,500 to determine your reduced benefit)

Married Filing Separately:
Ineligible

We hope this information will help you make the best decision when it comes to paying off your student loans and getting the maximum tax benefit for doing so. If you have any questions about student loan interest deductions, let us know in the comments below.

References: http://www.irs.gov/publications/p970/ch04.html

Image credit: Jordanhill School D&T Dept

Have you tried ReadyForZero yet? It's a free online tool for paying off debt.

Try it now

Receive updates:      
You can always unsubscribe by clicking on the link at the bottom of each e-mail.

  • http://debtperception.wordpress.com/ Debt Perception

    I hate the penalty for those of us who are married and file separately. I took on my student loan debt load before I even knew my husband existed and I do not want him to have to pay back any portion of my debt. We file separately because my payments would increase by $300 under IBR if we filed jointly.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s interesting. And it sounds like the penalty is not fair. But kudos to you for taking charge of your student loan payment on your own!

  • Guest

    “Because the ability to deduct student loan interest payments is limited to people earning under $75,000 per year (if single) or under $155,000 (if married), higher-paid graduates (e.g. MBAs, lawyers, and other grad students) have a narrow window within-which they can take advantage of the deduction: the year when they graduate.”
    This sentence is very confusing and/or misleading. Despite my graduate degree I’m never going to make over $75,000 a year—and I will be able to deduct interest as long as I’m paying it. The way this is worded implies something very different.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      You’re right – that sentence was confusing. I made some edits – hopefully it reads a little more clearly now. And yes, you’re absolutely right that you can deduct interest if you make below $75,000. I hope that is clear from the article now. If not, let me know.

  • J

    Can you please show us an example of calculating the partial benefit for married filing jointly, income between 125k-155k? I’m having some trouble calculating it. Thank you in advance.

    • http://mitchellwfox.com/ Mitchell Fox

      J – First off, we’d be happy to do the calculation for you if you sign up on GoodApril.com.

      In terms of calculating yourself, you’ll need to take your modified adjusted gross income (MAGI), and compare that to the $125K – $155K phaseout range. Let’s say your MAGI is $140K, or $15K over the $125K cutoff for Married Filing Jointly. $15K is 50% of the $30K phaseout range, so you can take 50% of the $2,500 deduction. To then get how much this should reduce your taxes by, you would multiple this number ($1,250) by your marginal tax rate (most likely 25%) to get the actual amount your taxes will go down, or about $312.

  • C

    How do I know that the student loan interest received by lender is correct on the 1098e form? I’ve calculated that I have paid over $3000 dollars in loans but the amount the loan institution gave me was just over $600.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      It might be worth calling the lender to double check that it was correct. One other thing to consider is that some of what you’ve paid has gone toward the principal, not the interest. So if you’ve paid $3,000 total, it’s possible that “only” $600 went toward the interest.

  • The IRS is stupid

    So can anyone tell me what the logic is behind why one loses their ability to write off student loan interest if they file “married but separate” ? The only answer I can think of is another way for the IRS to screw young people in the @ss…..

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      That’s a great question. I wish I knew the answer, but it does seem unfair, doesn’t it?

  • Gettingeffedbythefed

    Of course you can really get screwed if you pull out money to pay off your loans which makes your MAGI go above the threshold. Especially, when the required 10% early withdrawal amount is what takes your MAGI over the limit.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Thanks for clarifying that. And for those that aren’t familiar with the acronym MAGI, it stands for Modified Adjusted Gross Income.

  • indebted

    If I refinance my student loans through a bank or credit card with lower interest rates, am I still able to write off the interest every year?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Hi, to be honest I’m not sure of the answer to this question. My guess would be that those payments would no longer be considered student loan payments (unless you did a student loan refinance/consolidation loan). However, like I said, I’m not sure about this, so I’d recommend researching it further and maybe asking a tax professional.