Interest Paid on Student Loans

Recall from our discussion of Exhibit 1 on page 9 that the best type of deduction is an Above-the-Line deduction as the deduction is allowable whether or not the taxpayer is an itemizer (only the Itemized Deductions are taken in lieu of the standard deduction amount).  One of the few instances where a personal expense can be deducted as an Above‑the‑Line deduction is in the case of interest expense on student loans.  Interest expense on virtually any type of student loan qualifies.  The loan could have been used to fund tuition, books, fees, room and board or transportation expense. The loan must be used by a student enrolled at least half-time at an eligible (accredited) educational institution.

The maximum amount deductible each year is $2,500 of interest expense on such loans.  This deduction is available until the student loan is repaid (a 60-month limitation under old law has been repealed).

Recall that in the earlier discussion of Educational Credits and Educational Savings Bonds there was a prohibition against “double-dipping."  For example, you cannot take tax-free funds (such as exempt interest on an Educational Savings Bond) to pay tuition with it and also have those payments count toward computing your Educational Credit.  Here, however, there is a bit of “double-dipping” permitted.

Example:  Mark, (father) arranges to have Bryan (son) take out a student loan to fund his college tuition expense.  Bryan is solely or jointly obligated with Mark to repay the loan.  Bryan is Mark’s dependent in the year in which the tuition expense is paid.  Since Mark can count Bryan’s loan proceeds as an amount Mark is considered paying for tuition (see the Note on page 99), the loan proceeds pump up the qualified tuition expense Mark is deemed to have paid for Educational Credit purposes in the year in which the tuition is paid.  Four years later when Bryan graduates from college and is no longer Mark’s dependent, he begins paying back the loan.  Presuming he is within the AGI limits discussed below, Bryan will deduct the interest expense on the loan as an Above-the-Line deduction.

As noted in this Example, the person who is contractually obligated to repay the loan (as a sole or co-obligor) is the one who gets the deduction and furthermore that person cannot be a dependent on another taxpayer’s return in the year in which the loan is repaid.

Once again we have Adjusted Gross Income limits that phase out and eventually eliminate the tax benefit for interest expense on student loans.  For married taxpayers filing jointly, the phase-out starts at $100,000 of AGI and is gone entirely at $130,000.  For single taxpayers, the range is $50,000 to $65,000.

For more on-line information, go to my Web site, click on Educational Savings and then Interest Paid on Student Loans.