Taxpayers with current student loans are eligible for specific deductions under Internal Revenue Service (IRS) guidelines. These deductions apply to loan interest paid in a given year. They assist students in lowering the lifetime cost of their student loans by returning hundreds of dollars to their pockets. However, the regulations and procedures for claiming these deductions are pretty complex. This post will detail the rules for deducting student loan interest.
COVID-19 and Student Loans
First and foremost, a word to borrowers with federal loans guaranteed by the Department of Education (ED). In 2020, the ED launched an emergency initiative to assist national student loan holders in alleviating the financial impact of COVID-19. It contained three significant relief initiatives for those still owed money on their student loans.
- All necessary loan payments have been temporarily halted.
- The interest rate on all loans has been cut to 0%.
- Collection agency activities on delinquent loans were discontinued.
On August 6, 2021, the ED announced a final extension of the COVID-19 relief program. Loan payments, interest charges, and collections action on delinquent loans will start on February 1, 2022.
What Are the IRS Regulations Regarding Student Loan Interest Deductions?
The IRS tax subject number 456 explains student loan interest deductions. The guidelines allow for tax deductions on annual student loan interest payments of up to $2,500. To qualify, taxpayers must fulfil the following requirements:
- The interest on an eligible student loan must be paid.
- The claim must have been produced during the tax year in question.
- You had a legal obligation to pay the interest.
As a result, borrowers of ED-backed loans would face certain complications in the 2020 and 2021 tax years. Borrowers were temporarily released of their legal duties to make loan or interest payments as a result of the CARES Act. That does not apply to persons with private student loans or loans that the ED does not hold.
What Exactly Is a Tax Deduction?
Tax deductions are applied to taxable income. They can be used to lower the amount of income that is subject to federal taxation. Assume you earned $40,000 in taxable income and spent $2,000 on qualifying student loans. Your taxable income would be $38,000 after the $2,000 deduction.
People frequently mix up tax deductions with tax credits. Tax credits don’t lower your taxable income. Instead, they are deducted from your tax burden, which is the money you owe in taxes on your annual income. This IRS page describes the distinction in further depth.
What Other Laws Impact Student Loan Interest Deductions?
The IRS has several other qualifying restrictions for people who want to deduct student loan interest from their tax returns. First, you cannot take the deduction if you are married but living independently from your spouse. If you file jointly with your spouse, neither of you can be claimed as a dependent on the return of another individual. Finally, your household’s modified adjusted gross income (MAGI) must be below certain thresholds. These vary from year to year, but for 2021, they are as follows:
- Single filers should expect to pay between $70,000 and $85,000.
- Couples filing jointly might expect to pay between $140,000 and $170,000.
Individuals with earnings greater than $70,000 but less than $85,000 are still eligible for these deductions, although the maximums are decreased. The same applies to couples with MAGIs exceeding $140,000 but less than $170,000. You can also deduct required and voluntary payments up to the maximum allowed for your income level.
If your income falls between these thresholds, you will no more be able to claim the student loan fees tax deduction proportionately. For example, if you paid at least $2,500 in eligible interest on educational loans but earned $75,000 as a single filer over the tax year, you could only deduct two-thirds of that amount, or $1,667.
Similarly, if you earned $160,000 as a married couple filing jointly, you could only claim one-third of the $2,500 permitted deduction, or $833. Married couples with student debts are ineligible for the double deduction, worth up to $5,000 each tax year.
Which IRS Forms Are Required?
The IRS paperwork you’ll need to claim your deduction is determined by the amount of student loan interest you paid. If you paid less than $600, your lender will unlikely send you an IRS form. You can, however, still claim the tax deduction. If you require assistance, contact your student loan servicer or a loan representative at your institution.
You would require IRS Form 1090-E if you paid more than $600. You must also file IRS Form 1040 or 1040-SR.
Form 1090-E (Income Tax Return)
Form 1090-E, often known as a Student Loan Interest Statement, is an IRS form. You should automatically receive one if you pay more than $600 in tax on your educational loan. Your lender or loan servicer will also send an identical copy to the IRS.
The Student Loan Interest Statement will show how much you spent in loan interest over the year. The identical figure must be cited on your tax return (IRS Form 1040/1040-SR).
Form 1040/1040-SR of the Internal Revenue Service
IRS Form 1040 is a statement of the United States Individual Income Tax Return. Form 1040-A, its predecessor, was used until 2018. Form 1040-A has been superseded by Form 1040-SR, often known as the United States Tax Return for Seniors. Most persons who claim student loan interest deductions will utilize Form 1040. People over the age of 65, on the other hand, may be eligible to receive these benefits if they:
- They have a current student debt.
- Pay the interest on a student loan on behalf of a Dependant.
Refer to these IRS instruction instructions for the applicable form(s) for assistance filing your income tax return.
What Other Tax Breaks Are Available for Education?
You may be eligible for alternative programs if you cannot deduct student loan interest on your tax return. Other tax discounts and perks for higher education are available from the United States government.
The Lifetime Learning Credit (LLC) and the American Opportunity Tax Credit (AOTC) are common examples. You may be eligible for a tax break if you paid for your school through a 529 plan.
Credit for Lifetime Learning (LLC)
The IRS Lifetime Learning Credit applies to tuition and other qualified education costs. You may use it to pay for undergraduate, graduate, and professional degree programs.
The maximum LLC benefit is $2,000 per tax return. You can claim the credit for as many years as you qualify. You or your dependent must currently enrol in an appropriate school program to receive the honor.
AOTC (American Opportunity Tax Credit)
The AOTC is available to students in their first four years of a recognized higher education program. AOTC guidelines, like the LLC, limit the credit to students currently enrolled in school. You cannot claim it after graduating.
The AOTC offers an annual tax reduction of up to $2,500. One significant benefit of this program is that you can obtain monetary benefits. If the AOTC lowers your income tax to zero, you may be eligible for a refund of up to 40% of the excess amount.
