Student Loan Tax Deduction to Save Money

student loan tax deduction

If you have a student loan, it is not surprising that you are looking for money-saving strategies. While many borrowers focus on loan forgiveness and repayment options, there also exist tax deduction opportunities with great benefits. It is possible to qualify for up to $2,500 student loan tax deduction due to educational expenses per tax year. However, first, you should check your eligibility for these programs. We present the following deduction and tax credit opportunities in this guide:

  • Student Debt Interest Deduction
  • American Opportunity Credit
  • Lifetime Learning Credit
  • Qualified Tuition Programs 
  • Coverdell Education Savings Account

Are Student Loans Tax Deductible?

Some educational expenses are subject to tax credits, while you can also get a student loan tax deduction for interest payments. There is a significant difference between a tax credit and a tax deduction. Credit is applied to the tax amount directly. Meanwhile, the deduction decreases the income subject to tax. 

Besides, currently, Sen. Rand Paul is working on new legislation to make student loans 100% tax-deductible. Check out the details in the following section.

New Tax Deduction Bill

While many borrowers wait for student loan cancellation opportunities, tax deduction can bring even greater benefits. Currently, Sen. Rand Paul is developing new legislation on student loan tax deduction. This legislation is called the “Tax-Free Education Act,” and it has multiple benefits for student loan borrowers. 

Based on the legislation, educational expenses should be free of taxes. As a result, borrowers would be able to deduct 100% of their educational expenses from their income taxes. This bill involves student loans as educational expenses, which means you would pay no taxes for these costs. Even better, the bill covers all schools and applies to K-12 education costs.

The reasoning behind this legislation is that borrowers are already struggling with debt repayment. A lot of people in their thirties are still paying their debt obligations. Meanwhile, education costs are higher than ever. 

If Congress approves this legislation, student loan borrowers could save thousands of dollars. Although student loan forgiveness is more attractive in the news, you should also keep an eye on this bill as its benefits cannot be underestimated.

Student Loan Tax Deduction vs. Loan Forgiveness

As mentioned before, many borrowers expect Biden’s loan forgiveness opportunities. However, if you wait for immediate forgiveness, you might waste your time. The Biden administration is currently working on targeted loan forgiveness programs that cover some groups of borrowers- disabled debtors, students whom the schools misled, etc. It is unlikely that borrowers will get direct forgiveness soon. 

The loan forbearance (non-repayment) period is expected to end in February 2022. The massive loan repayment process will start on this date, and it is still unclear if borrowers fixed their finances after the pandemic. Hence, even if direct loan cancellation is not accessible, legislators are working on alternative options to benefit students. Sen. Rand Paul’s student loan tax legislation is also one of these plans to help struggling borrowers. Yet, you can also explore your options for saving money without wasting time by expecting new opportunities. We will discuss existing options in the following sections. 

Student Debt Interest Deduction

Generally, personal interest is not tax-deductible. This rule might exclude some mortgage interests. However, some borrowers can get a student loan tax deduction for the interest they pay. These borrowers should have Modified Adjusted Gross Income (MAGI) less than $85,000. If you are filing a joint return, this amount is doubled. If you are not sure what your MAGI is, do not worry. You can find this item in your tax return as it covers the amount before deducting any student loan interests. 

The benefit of this student loan tax deduction is that you can save up to $2,500 from taxes. As your interest is deducted from income, there is less taxable income. Keep in mind that the program prohibits double benefits. This case happens when your interest is deductible under other benefit programs. You cannot get a double deduction. 

Eligibility for the Interest Deduction

student loan tax deduction

There exist some qualifications you should meet before requesting a deduction. First, your loan should be taken for educational purposes. Besides, you cannot get a loan from a relative or through an employer plan. A student can be a spouse or a dependent like a child or relative. Yet, for you to qualify, you need to enroll in education at least half-time, which will bring you a degree or recognized certification in the future. Plus, almost all public, non-profit or private schools with proper accreditation should qualify for the program. Moreover, a school should be eligible to participate in federal student aid programs.

Remember that your required and voluntary interest payments can qualify for this student loan tax deduction. 

What is Included in Educational Expenses?

We mentioned that this student debt interest deduction is available for loans that are incurred for educational purposes. But what do educational costs include? It covers various expenses, from tuition to accommodation, books, equipment, transportation, or supplies. 

What does Interest Amount include?

This student loan tax deduction does not only cover simple -voluntary and required- interest payments. Other elements of your student loan can also be considered as interest and get deducted from your income tax. For example, origination fees can be considered as interest in some cases. An origination fee is a one-time payment for the money or service like processing costs. In case your origination fee is for the money directly, you might get a tax deduction for it. 

Additionally, capitalized interest can qualify for this benefit. When interest payments accrue during in-school deferment or grace period, they get added to the original debt balance. This period is called capitalization. You can request a tax deduction for the capitalized amount. However, keep in mind that student loan tax deduction will not be available for capitalization if you have not made any payments during a year. In other cases, you can get a tax deduction for revolving lines of credit or refinancing and consolidation loans. It is advisable to check the official website of the Internal Revenue Service or contact our debt specialists.

Income Level and Deduction Amount

As mentioned before, you cannot qualify for this student loan tax deduction if your MAGI is more than $85,000. Below this threshold, you are eligible for the interest deduction. However, the deduction amount changes depending on how much your income is. For example, if you are single and earn between $70,000 and $85,000, you will face a phaseout. It means your deduction will be reduced. Yet, below $70,000 faces no phaseout. For filing joint returns, the phaseout happens for borrowers earning between $140,000 and $170,000.

American Opportunity Credit

According to the Internal Revenue Service, another student loan tax deduction can be the American Opportunity Credit. This program allows up to $2,500 tax credit for qualified education expenses for eligible students. Tax credits can decrease the income tax that an individual should pay. However, there is a difference between student debt interest deduction and the American Opportunity Credit. Interest deduction decreases the amount of income subject to tax. Hence, you get a lower tax amount. Yet, American Opportunity Credit grants tax credits that directly decrease the amount of tax. 

Besides, another benefit of this student loan tax deduction is that 40% of it is refundable. So if your tax is less than 40% of this benefit, you will be refunded the remaining amount. 

Who Qualifies for American Opportunity Credit?

You can get the credit for your spouse’s or your dependent’s educational expenses. The student should still be enrolled in a 4-year degree program as of application. The program should lead to a degree or recognized credential. Besides, students cannot be convicted of a felony due to distributing or owning a substance. 

The MAGI limit also applies to this program. If you are single, your MAGI can be up to $90,000. Earning higher than this amount can disqualify you. In the case of filing jointly, the MAGI level is increased to $180,000. Keep in mind that married filing separately is not eligible for this student loan tax deduction. 

Qualified Educational Expenses

Educational expenses for studying in a qualifying school can be considered in this program. Qualifying schools can be public, not-for-profit, or private with proper accreditation. Besides, the school should be allowed to participate in student aid programs.

Education expenses cover a wide variety of costs. However, the general rule is that the cost is incurred for items required by the school. In other words, you need to incur these costs to study. Hence, tuition and fees, books, supplies, equipment, etc., qualify for this student loan tax deduction. Besides, keep in mind that you do not even need to buy these supplies or books from the educational institutions to get a tax deduction. Meanwhile, your medical expenses, accommodation, transportation costs, or expenses for noncredit courses, hobbies do not qualify for the tax deduction.

Similar to student debt interest deduction, you cannot get a double deduction for the same amount. 

Earning Level and Tax Credit

Similar to student debt interest deduction, this program has a phaseout. If your MAGI is between $80,000-$90,000, your tax deduction benefit will be subject to phaseout and get reduced. If you earn more than this amount, you are not qualified for this student loan tax deduction. Earning less than this amount makes you eligible for the full benefit without phaseout.

Note: Please, check Internal Revenue Services to get complete details on American Opportunity Credit and student debt interest deduction regarding the full eligibility list, the application process, etc. 

Lifetime Learning Credit

student loan tax deduction

Another tax credit program, similar to American Opportunity Credit, is Lifetime Learning Credit. You can qualify for credits worth up to $2,000 educational expenses during a tax year. You can claim these tax credits as many times as you wish for an eligible student. 

As explained before, tax credits decrease the income tax amount directly. Meanwhile, the deduction decreases the income that is subject to tax. Different from American Opportunity Credit, there is no refund in this program. It means you can get a total tax reduction with this program, but even if there is still some amount of credit left, you cannot get refunded. 

You might qualify for both American Opportunity Credit and Lifetime Learning Credit. However, for a tax year, you should choose one. You cannot request both options for a single student. Yet, if you have two student dependents whose educational expenses qualify for the tax credit, you can ask for both credit programs – one for each student.

Who can Request the Credit?

A variety of taxpayers can qualify for tax credits. You might request credit for your education, a dependent, or a spouse. However, the student should be studying in a qualified school. Besides, all expenses should be incurred for educational purposes.

More Details

If you request this student loan tax deduction, your Modified Adjusted Gross Income should be up to $69,000 for single taxpayers and $138,000 for married filing jointly. As mentioned, your tax benefit can be up to $2,000, and there is no refund for the excess amount. Besides, it is available for as many years as you wish to maintain eligibility. 

Another advantage of this student loan tax deduction is that you do not need to enroll in a program that leads to a degree or recognized credential. Moreover, even if you have a drug conviction history, this qualification will not make you ineligible. 

Lastly, the phaseout is still applicable for this tax deduction opportunity. If your MAGI is between $59,000 and $69,000, your tax credits can be reduced. Earning less than this limit grants you full benefit, and higher than this limit makes you ineligible. In addition, the amount is doubled for married filing jointly ( which means the phaseout is applicable between $118,000- $138,000).

Qualified Tuition Program

In some cases, states or schools create a Qualified Tuition Program account. Individuals can prepay or contribute to this account for paying educational expenses. You can contact your state government or educational institute to determine if they participate in this program.

The benefit of the Qualified Tuition Program is that the amount from this program is not subject to taxes. However, the exception applies if the distributed amount exceeds the beneficiary’s adjusted qualified education expenses. These expenses include any costs required to attend a school, including tuition, fees, books, supplies. 

Coverdell Education Savings Account (ESA)

Coverdell ESA is similar to the Qualified Tuition Program as individuals can contribute to this account for educational expenses. The expenses can be for one beneficiary, and the total amount can be up to $2,000. You cannot open multiple accounts and exceed this amount. The contributions in this account are not tax-deductible. However, it is tax-free as long as the amount is in the account.

Note: Please, check the official Internal Revenue Service to get details on each student loan tax deduction discussed in this guide. The rules might change by the reading date, and it is always advisable to review the full list of terms and requirements. 

Final Words

This guide presented tax deduction and tax credit programs available to student loan borrowers. However, keep in mind that we covered only the essential details, and you are advised to check the official IRS website or contact a debt specialist for more detailed information. If, after reading this guide, you find out that you do not qualify for any student loan tax deduction, do not worry. You can still save money by debt management strategies like refinancing. Check out our blogs to know your options.