What You Should Know About the Student Loan Interest Deduction

January 29, 2018 · 5 minute read

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What You Should Know About the Student Loan Interest Deduction

Let’s be honest: Does anyone actually look forward to doing their taxes? The whole process feels like an overly complex homework assignment from a very detail-oriented and strict teacher.

But the next time you find yourself frantically searching for your W-2 form or trying to figure out where you put the shoebox with your receipts, think about the money you might get back from your deductions. After all, if you paid student loans this year, you might just qualify for the student loan tax deduction. It could be like Christmas or Hanukkah or Kwanzaa—in April.

If you’ve already started planning for what you could do with all the cash you might get back in a tax refund, you should know that not everyone qualifies for the student loan tax deduction. There are a number of requirements you have to meet in order to be able to take advantage of this deduction, including income requirements.

So whether you’re considering putting your refund toward going skydiving for the first time, or you’re planning to use it to pay off more student loan debt (both good options!), here is are some things you should know about the student loan interest deduction, how it works, and whether you qualify.

How the Student Loan Tax Deduction Works

Unfortunately, the student loan tax deduction isn’t a magical discount that’s taken off your monthly student loan payment like a coupon at the grocery store checkout. Instead, you pay the interest out of pocket throughout the tax year and claim the amount of interest you paid when you do your taxes.

This interest must be paid on qualified student loans that were used for course-related educational expenses such as fees, books, supplies, and equipment that are required for the courses.

If you qualify for the full deduction, you can reduce your taxable income by up to $2,500, as long as you actually paid that much in interest. Not only do required interest payments count, but if you made any additional interest payments toward your student loans this year, those count too.

Understanding How Interest Is Calculated for Student Loan Deductions

Unfortunately, you can’t deduct the entirety of your student loan payments from your taxes. If you could, the government might have to refund most of the tax dollars recent graduates pay. Instead, you can only deduct your interest.

To throw another curveball into the mix, the way the IRS calculates your interest and principal payments could be different than what your loan servicer reports. Your loan provider reports this information on a Form 1098-E, which is a tax form financial institutions should send out to borrowers when the tax year ends.

The only reason you wouldn’t get one is if you paid less than $600 in interest on their loan. But these forms don’t always report things like the interest you paid on certain origination fees or capitalized interest, which also qualifies for the student loan deduction.

How to Calculate the Student Loan Tax Deduction

To calculate the full value of your deduction, you need to start with the amount of interest these forms say you paid, and then add the interest you paid on qualified origination fees and capitalized interest. Just make sure these amounts don’t add up to more than the total you paid on your student loan principal.

Clear as mud, right? Hey, no one said the IRS liked things to be easy! Here are some examples of how to deduct these amounts.

Deducting the origination fee: To deduct the origination fee, you can use any reasonable method to allocate the loan origination fees over the term of the loan. One way to do this is to figure out how much the fees will cost you on a monthly basis over the life of your loan.

Example: If the origination fee you were charged on your loan was $1,000 and the term length was 10 years, or 120 months, that would mean your origination fee would be $8.33 per month, or $100 per year.

Remember: You shouldn’t include loan origination fees as interest if they are payments for property or services provided by the lender, such as commitment fees or processing costs.

Deducting capitalized interest: If your Form 1098-E says your loan has capitalized interest, you can also claim that, but after you’ve claimed your origination fee deduction.

Example: If you made $6,000 in student loan payments, of which $1,000 went to interest and $5,000 to your principal, you can claim the $100 you paid toward your origination fee and the full $1,000 in capitalized interest. But if you only paid off $750 of your principal, you can claim $650 of the $1,000 of capitalized interest, because you’ll have to claim the $100 in origination fees first and you can’t exceed the amount you paid toward your principal.

How to Qualify for the Student Loan Tax Deduction

Before you pick out the color of your sky-diving parachute or decide which loan you’ll put your refund toward, it’s important to figure out if you qualify for the deduction. To cash in on this deduction, all of the following must apply: You paid interest on a qualified student loan during the tax year. The loans must have been taken out for you, your spouse, or being paid by you on behalf of your dependent.

Your filing status isn’t married filing separately; you or your spouse, if filing jointly, can’t be claimed as dependents on someone else’s return. You’re legally obligated to pay interest on a qualified student loan. Last, your modified adjusted gross income (MAGI) is less than a specified amount which is set annually. The loans in question can be either federal or private student loans.

What You Should Know about Income Requirements

The student loan interest deduction is a tax deduction available only to those whose modified adjusted gross income (MAGI) falls into certain income brackets. Your MAGI is calculated on your federal tax return before any student loan interest deductions are made. The eligible ranges are recalculated annually.

For the 2016 and 2017 tax year, to qualify for the full credit, you need to make under $65,000 as an individual filer. If you make between $65,000 and $80,000 you still get the benefit, but it is reduced.

Similarly, if you file with a spouse, you qualify for the full credit if your household income is less than $130,000. Households bringing in between $130,000 and $160,000 qualify for a partial deduction.

Getting Help If You Need It

Confused by all these requirements? If so, consider going to a tax professional to help with your return to make sure you can take advantage of the deduction. That way you can enjoy the tax benefit without having to spend hours combing through the IRS’ website for answers.

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SoFi does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
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