With the costs of higher education increasing each year, the deductibility of interest paid on student loans is an important tax topic for many younger individuals. However, taxpayers are sometimes surprised to learn that there is a phase-out for various applicable income levels for this deduction, and above certain income levels, the deduction is completely eliminated.
This article will briefly explain the basics of the deduction for interest paid on student loans, as well as the deduction phase-outs. This explanation is not intended to convey tax or legal advice.
Student Loan Interest
Under IRS tax rules, interest paid for personal loans is typically not deductible for taxpayers; however, there is an exception to this general rule for interest paid on higher-education student loans (also referred to as education loans). Because this deduction is taken as an adjustment to income, qualifying taxpayers may claim this deduction even though that may not itemize their deductions on Form 1040 Schedule A.
In order to qualify, a student loan is required to have been taken out solely to pay qualified education expenses, and the loan must not be from a related person or made under a qualified employer plan. Also, students claiming the deduction must either be the taxpayers themselves, their spouses, or their dependents, and students must be enrolled at least half-time in a degree program (see applicable IRS publications for more specific definitions).
For 2013, qualifying taxpayers may reduce the amount of their income subject to taxation by the lesser of $2,500 or the amount of interest actually paid with this deduction. Taxpayers may claim the deduction if all of the following requirements are met: (1) they file under any status except married filing separately, (2) the exemption for the taxpayer is not being claimed by somebody else, (3) the taxpayer is under a legal obligation to pay interest on a qualified student loan, and (4) interest was actually paid on a qualifying student loan.
Student Loan Interest Deduction Phase-outs
The amount that a taxpayer may deduct for student loan interest paid is subject to phase-outs based upon their filing status and their Modified adjusted gross income (MAGI). For most taxpayers, MAGI will be their adjusted gross income (AGI) as determined on Form 1040 before the deduction for student loan interest is subtracted.
For taxpayers filing as single, head of household, or qualifying widow(er), and making not more than $60,000 MAGI, there is no reduction of the deduction. For taxpayers in those categories making more than $60,000 MAGI but less than $75,000, the phase-out will apply, and for taxpayers making more than $75,000 MAGI, the deduction will be completely eliminated.
For taxpayers filing as married filing jointly, and making not more than $125,000 MAGI, there is no reduction of the deduction. For taxpayers in those categories making more than $125,000 MAGI but less than $155,000, the phase-out will apply, and for taxpayers making more than $155,000 MAGI, the deduction will be completely eliminated.
The phase-out itself is usually determined by the following calculation: a taxpayer’s interest deduction (before the phase-out) is multiplied by a fraction. The numerator is the taxpayer’s MAGI minus $60,000 (or $125,000 for married filing jointly), and the denominator is $15,000 ($30,000 for married filing jointly). The result is then subtracted from the original interest deduction (before the phase-out), and this amount is what the taxpayer may actually deduct.