If you are one of the over 70 percent of college students using an average of almost $30,000 in student loans to cover the ever escalating costs of obtaining a degree, some tax benefits of repaying the loan may be available to you but may not be as lucrative as you may think.
In general, up to $2,500 of the interest you pay on a qualified student loan is deductible subject to your modified adjusted gross income (MAGI – adjusted gross income with certain adjustments) phase outs. Although this is an above-the-line deduction in that it reduces your gross income directly to compute adjusted gross income (you don’t need to itemize), there are several restrictions that limit any actual tax benefits.
The IRS defines a qualified student loan as one obtained solely to pay qualified education expenses for yourself, your spouse, or a dependent (child or relative) that were paid or incurred within a reasonable period of time before or after the loan was taken for education provided during an academic period for an eligible student who is enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. Student loan interest of $600 or more is reported on Form 1098-E.
Costs Include:
- Tuition and fees
- Room and board
- Books, supplies and equipment
- Other necessary expenses such as transportation
Loans from a related person or qualified employer plan (i.e. 401k, 403b, 457 etc.) do not qualify.
For 2015, your MAGI must be below $65,000 ($130,000 if married filing jointly) to realize the full benefit of the interest deduction that completely phases out once your MAGI reaches $80,000 ($160,000 if MFJ). Furthermore, no deduction is available to married taxpayers who file separately.
An important requirement to consider is that the individual claiming the deduction must be legally obligated to make the loan payments and that no one else claims that individual as a dependent. For loans where both the student and their parents are legally obligated, the parents may take the interest deduction as long as they claim the student as a dependent. If, however, only the student is legally obligated and is claimed by the parents as a dependent, no one is entitled to the interest deduction. It is not always clear who the debtor is merely by looking at Form 1098-E. In many instances, the 1098-E reports the interest in the student’s name and social security number. In such cases, it is recommended that the actual loan document be reviewed to determine the actual obligors.
So what is the student loan interest deduction really worth? Well, based on these criteria, $65,000 ($130,000 MFJ) of taxable income puts you in the 25% tax bracket. So, if you have paid at least $2,500 in interest, the maximum annual benefit is $625 (plus any state savings). While there are several factors to consider in determining whether to pay off your student loans early, from a tax standpoint, a recent college graduate in a new career who expects their income to rise over time should at least consider the fact that they will likely lose any tax benefit of student loan interest deductions in the future. In this scenario, it may make sense increasing your payments in the early years if cash flow allows, thereby ensuring that you pay all interest as it accrues rather than making only the monthly payments required under a deferred, graduated or extended repayment plan. This might maximize your tax write offs in the early years when your income is lower, decrease the lifetime interest of the loan as well as shorten its term. This would put you in a great position to tackle life’s next great obstacle – obtaining a mortgage.
If you have questions, please contact Victor C. Belgiorno of DSJ at 516-861-3704 or .