If you are like the average college graduate and have $37,000 in student loans to repay, a portion of your monthly payment is for accrued interest. If you didn’t know it, you can deduct your student loan interest payments on your federal taxes! This is one way anybody can save money on their student loan bills.
Itemization Isn’t Required
Unlike other tax deductions, home mortgage interest for example, which can only be claimed by itemizing, student loan interest as part of your adjusted gross income. Just like pre-tax 401k contributions and employer health insurance premiums reduce your taxable income, the first $2,500 in student loan interest each year does as well.
The fact that you don’t need to itemize is great. This is because many recent college graduates and other working families with limited incomes often do not qualify for itemizing their taxes. To itemize as a single person in 2016, you would have to have a combination of at least $6,300 in charitable contributions, mortgage interest, and other eligible expenses to qualify. Married couples would need at least $12,600 in eligible deductions to begin itemizing. That’s a lot of money to spend on a few particular categories.
You Can Deduct Student Loans Up To $2,500 Each Year
If you file as a single person, you can deduct up to $2,500 in interest paid. Married couples that file jointly can deduct up to $5,000 ($2,500 for each person) to reduce their adjusted gross income.
How do you know how much to deduct?
Your lenders will send you a form 1098-E that will tell you how much interest was paid. If you file your taxes electronically, the tax prep software will prompt you to type in the dollar amount printed in that box (box 1).
Even if you paid more than $2,500 in interest for the year, still type in the total figure. These documents are also furnished to the IRS and it will help keep the accounting consistent.
And, whether you think you qualify for the deduction or not. Still, submit the information as you for sure will not qualify if you don’t tell the IRS that you paid the interest in the first place.
There is an Income Phaseout
Unfortunately, like other tax credits and deductions, the IRS does have an income phaseout. This means you have to deduct less student loan interest once you make a certain amount of income.
The table below will indicate if you can still qualify for a reduced deduction:
|Filing Status||Phaseout Begins||Phaseout Ends|
|Head of Household||$65,000||$80,000|
|Married Filing Jointly||$130,000||$160,000|
This table applies to the 2016 & 2017 tax years, the IRS recalculates most deductions on a yearly basis and the 2018 figures will be released in late 2017.
Looking the above table, you can deduct the full $2,500 in interest when your income is less than $65,000 when your filing status is single. After that meeting that income threshold, you can deduct interest paid until you earn $80,000 when you cannot deduct any interest at all.
How to Maximize the Student Loan Interest Tax Credit
Depending on your current loan balance and interest rate, you might not have any issue paying $2500 in interest this year. Whether you pay that much or not in interest annually, nearly every graduate has the opportunity to “max out” the credit at least once in their lifetime.
This is when their loans first enter repayment status after being fully deferred in college. Shortly before your loan grace period ends, each lender will send you a statement stating an amount of unpaid interest that needs to be paid in full before the loan enters repayment status to avoid having the interest compound and essentially start paying interest on interest & increasing the total cost of your loan.
As you will more than likely have at least $2,500 in deferred interest. Making a lump-sum payment not only pays down your loan, but, it helps reduce your tax bill as well.
The student loan interest tax deduction is one of the easiest ways to reduce your adjusted income. Your 1098-E will be mailed in late January and be sure to include the form on your tax return. It could mean the difference between a refund and have to give Uncle Sam even more money.