Tax Deductions for Student Loan Interest

Elizabeth Rosen
by Elizabeth Rosen, Contributor

The Student Loan Interest Deduction is an education tax benefit that allows taxpayers to deduct up to $2,500 of the interest paid on student loans. This education tax deduction can be claimed on your federal income tax return to reduce your taxable income.

Deductions lower your taxable income and they are worth the percentage equal to your marginal tax bracket. For instance, if you are in the 25% tax bracket, a $1,000 deduction saves you $250 in tax (0.25 x $1,000 = $250). On the other hand, credits lower your taxes. Tax credits provide a dollar-for-dollar reduction of your income tax liability. For instance, a $1,000 tax credit actually saves you $1,000 in taxes. A tax credit is always worth more than a dollar-equivalent tax deduction, because deductions are calculated using percentages. Referring to the numbers above, you can see that a $1,000 credit offers a savings of $750 more than a $1,000 deduction.

Student loan interest is the interest that you paid during the year on a qualified education loan. You can deduct all the interest you paid on your student loan during the year, which includes voluntary interest payments.

You may claim the student loan interest deduction if you meet all of the following requirements:

• Your filing status is not “married filing separately”

• You (and your spouse if filing jointly) are not claimed as a dependent in the Exemptions section of another person’s tax return

• You are legally obligated to pay interest on a qualified student loan

• You paid interest on a qualified student loan

A qualified student loan, or education loan, is defined as follows:

• A loan that you took out solely to pay for qualified higher education expenses

• A loan that is used for an eligible student (you, your spouse, or your dependent) who is enrolled in a degree program at least half-time

• A loan that is not from a relative or qualified employer plan

The amount of your education tax deduction is based on your income level. The maximum amount you can claim for the student loan interest deduction in 2009 is $2,500. The size of your tax deduction is gradually reduced if your modified adjusted gross income (MAGI) is between $60,000 and $75,000 (or $120,000 and $150,000 if filing jointly).

If your MAGI is $75,000 or more ($150,000 or more if filing jointly), you cannot claim this education tax deduction. Additionally, you cannot deduct the interest on a loan you get from a relative (such as your spouse, sibling, half-sibling, parents, grandparents, children, and certain organizations).

The following items cannot be claimed for a student loan interest tax deduction:

• Interest that you paid on a loan if you were not legally obligated to make interest payments under the loan terms

• Fees for lender services, such as loan origination fees and processing costs

• Interest payments that you made through a loan repayment assistance program (such as the National Health Service Corps Loan Repayment Program, NHSC)

To claim the student loan interest deduction, you must include it as an adjustment to your income. (Note: you do not have to itemize your deductions for this education tax benefit.) The tax deduction can be claimed by entering the allowable amount of your deduction on Line 33 of IRS Tax Form 1040 (or Line 18 of Form 1040A; or Line 32 of Form 1040NR; or Line 9 of Form 1040NR-EZ).