The numbers can be staggering. During 2016, the accumulated student loan debt in the United States exceeded $1.4 trillion. Correspondingly, the average 2016 college grad accepts their diplomas with debt of approximately $37,000. A majority of the debt is in the student’s name, but some parents that assisted in the borrowing process also have loans. Associated with the debt is the monthly interest that is either owed or accrued on these loans. So who gets to deduct this interest and how much of the interest is tax deductible?
A qualified student loan is a loan you took solely to pay qualified education expenses for you, your spouse, or a person who was your dependent when you took out the loan. Loans from related persons and from qualified employer plans are not student loans. You meet the qualifications to deduct the interest if you meet the following four standards; your filing status is any filing status except married filing separately; no one else is claiming you as an exemption on another return; you are legally obligated to pay interest on the loan; and you paid the interest.
Parents that assist in paying student loans that are not in their name cannot claim the interest as a deduction even if the student is still a dependent. Parents that took out loans in their name, such as a Parent Plus loan, are obligated to make the repayments and are the only ones eligible to deduct the interest. If the student is receiving assistance in the form of a gift to help pay their loans, the gifts should be documented or the gift should be deposited into the students account so that the student can make the loan payment and receive the deduction.
A deduction of up to $2,500 of student loan interest paid during a tax year can be deductible. The deduction is not an itemized deduction but an adjustment to gross income. As with many deductions the rules are not that straight forward. There are income limitations depending on your filing status. Single taxpayers with adjusted gross income before considering the loan interest deduction of $65,000 or less and married taxpayers with income of $130,000 or less are not limited. Income above these limits start to phase out the deduction, and when income exceeds $80,000 for single taxpayers and $160,000 for married taxpayers no deduction is allowed.
To help calculate the deduction, you should receive a Form 1099-E each year from the lender. The form will provide the student loan interest received by the lender. The 1099-E will also list the borrower’s name; this should be the person responsible for the loan not who made the payments. Since the IRS, receives this information, care should be taken to make sure the proper person takes the deduction.
As mentioned above the average grad in 2016 is walking away with both a diploma and very large debt. For those students, fitting into the norm of $37,000 of debt, they can expect to pay over $14,000 in interest when paying back the loan in the normal 10 year repayment period. Hopefully the tax benefit can ease the pain slightly.