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What You Need to Know About Student Loan Interest

by
Spencer Wilson
on
7/15/2019
What You Need to Know About Student Loan Interest

Student loans are all over the news today, as an estimated 43 million Americans carry federal student loans totaling $1.6 trillion in debt. There is an additional $119 billion outstanding in student loans from private sources. While legislators struggle to find a solution to the overwhelming costs of higher education, every day people continue to take out loans. If you are one of them, it’s important that you remember to take advantage of the student loan interest deduction.

Though many people believe that this deduction is only available for interest paid on government student loans, that is not the case. As long as the funds that you borrow are used exclusively for qualified higher-education expenses, you are permitted to deduct interest up to $2,500 per year. That includes loans from private banks, home equity lines of credit, government student loans, personal loans from unrelated parties, and even using credit cards. The only real exclusions are loans from relatives and loans from pension plans.

The deductions can be taken on a wide range of loans and can be used regardless of whether you itemize or claim the standard deduction. This is because it is an above-the line deduction that adjusts total income.

It’s important to remember that there are a few restrictions on the use of this deduction:

  • It is not available to higher-income taxpayers and is phased out for taxpayers with an Adjusted Gross Income of $70,000-85,000 (for married filing jointly the phase-out is between $140,000-$170,000).
  • It’s not available at all for those who file married but separate or for people who are written off as another taxpayer’s dependent.
  • The need for the loan to be for a sole purpose is strict. The two examples below represent situations where the deduction cannot be taken:

Example #1 – Grant takes out a $30,000 home equity loan and uses it to finance a $20,000 solar installation on his home and $10,000 to pay his son’s qualified education expenses. This loan is not a sole-purpose loan because of the solar energy expense, and therefore Grant can’t deduct the interest – even a part of it – for the student loan interest deduction. He can, however, prorate the amount that he borrowed for the solar equipment as long as the total debt doesn’t go over the acquisition debt limits. If Grant had wanted to deduct $2,500 of home equity line interest using the student loan deductible, he would have had to limit the use of the loan to qualified education expenses.

Example #2 – Meryl has a Discover card that she uses to pay a variety of bills and expenses. She also used it to pay for her graduate school expenses. Had she used the card exclusively to pay for tuition, she could have deducted any interest on the borrowed money, but because she also spent on other things, she is unable to do so. With credit card interest rates being so high, this is probably a good thing – there are other ways to borrow money that are much less costly.

Here are the requirements for the student loan interest deduction:

  • The monies borrowed must have been used for tuition, fees, room and board, books and equipment or other necessary expenses (including transportation) related to attending an eligible educational institution during the time that the person was a qualified, eligible student.
  • An eligible student is defined as a person who is taking at least half a normal course load at the school being attended and who is pursuing a degree or certificate program. A full-time course load is generally a minimum of 12 credits.
  • An eligible educational institution is defined as any university, college or vocational school that the department of Education has deemed eligible to participate in their student aid program. This covers almost every private post-secondary school and accredited public post-secondary school in the country. Eligibility also extends to postgraduate training available through healthcare facilities, hospitals and other higher education institutions that offer internship or residency programs that culminate in the student earning a certificate or degree.
  • To qualify for the deduction, the expense for which the loan was taken out must fall within a reasonable time from when the debt was incurred, though it doesn’t matter whether it was before or after. ‘Reasonable’ is defined as:
  • When the proceeds of a loan from a federal post-secondary education loan program are used to pay the debt; or
  • When the funds are disbursed within a 180-day period starting 90 days before the start of a particular academic period and ending 90 days after that period. If a home equity line of credit is taken out for educational expenses, it is permissible to pay expenses as they become due as long as the loan was taken out and used for the sole purpose of paying the education expenses.

To take advantage of the educational interest deduction for a student loan that is not financed, guaranteed, or subsidized under either an eligible educational institution or a local, state or federal government institution, the taxpayer will need to provide the lender with a certification that the monies borrowed are being used exclusively for expenses for qualified higher education. You can do so by using IRS Form W-9S — Request for Student’s or Borrower’s Social Security Number and Certification.

When calculating college expenses and ensuring that the monies are being used appropriately be sure to exclude the following:

  • Any allowances, grants or scholarships, as well as distributions from 529 plans, all of which can be excluded from gross income
  • Employer-provided tuition reimbursement
  • S. savings bonds used to pay for higher education expenses
  • Coverdell ESA distributions (nontaxable)

Eligibility for the education loan interest deduction is restricted to the borrower who is legally responsible for making the payments on the loan, though payments on the loan can be made by somebody else. In doing so, the payments are considered by the IRS to be a gift.

The higher-education loan interest deduction can have great value, but you need to be sure that you are eligible to take it. For more information, contact a tax professional to discuss your particular situation.

Spencer Wilson writes for TaxBuzz, a tax news and advice website. Reach him at [email protected].

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Spencer Wilson

Spencer Wilson

Spencer Wilson, EA is a tax preparer based in Long Beach, CA. Spencer Wilson Financial Management Services has been serving the Greater Los Angeles Area and Orange County since 2004. <br /> We began in the heart of Naples in Long Beach and we continue to work hard offering tax preparation and planning, business accounting and bookkeeping and payroll services . <br /> We have helped many different people and businesses succeed financially and take control over their finances.

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