Student loans have been a hot topic in the media and on Capitol Hill. A recent analysis of student loan trends from the credit bureau Experian found that student loan debt increased by 84% from 2008 to 2014, surpassing the debt related to home equity loan and lines of credit, credit cards and automobiles. Currently, the average student graduates with around $29,400 in loans and 58% of all student loan debt is held by families in the bottom 25% of household incomes.
Not surprisingly, the tax law related to the student loan interest deduction has not kept up with such growth.
The interest paid on student loans has been specifically included as a deductible expense under our tax laws since the Taxpayer Relief Act of 1997. Prior to that, it had been considered non-deductible personal interest, just like interest paid on a credit card, since 1986. Under TRA 1997, taxpayers with student loans could deduct interest paid on student loans as an “above the line” deduction, lowering their adjusted gross income (AGI). The above the line deduction can be taken regardless of whether you itemize.
In 1998, the maximum amount of student loan interest that could be deducted was $1,000; the amount increased to $1,500 in 1999, $2,000 in 2000, and $2,500 for 2001 and the years following. Additionally, under TRA 1997, the deduction was only available for interest payments made during the first five years in which interest payments were required on the loan. In 2001, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the five year rule was lifted. At the time, the elimination of the five year rule was only temporary, but has since been permanently extended.
As with any tax law, there are a laundry list of rules and limitations to the deduction:
- If you are married and file Married Filing Separately, you cannot take the deduction.
- Regardless of your filing status, you cannot take the deduction if you can be claimed as an exemption on anyone else’s tax return, even if you made the student loan interest payments.
- You must have taken out the loan solely to pay for educational expenses. This means you can’t tack on education costs to a personal loan and expect to deduct the interest.
- The loan cannot be from a related person or made under a qualified employer plan.
- The student must be you, your spouse, or a dependent and must have been enrolled at least half time in a degree program at an eligible educational institution.
- The deduction is phased out for taxpayers with Modified Adjusted Gross Income (MAGI) between $60,000 and $75,000 if single or head-of-household, and $125,000 to $155,000 if married filing jointly.
Recently, a bill was introduced that would double the student loan interest deduction limit for low-income married couples. The Student Loan Interest Deduction Fairness Act, introduced by Rep. Mark Pocan, D-Wisconsin, would allow married couples to deduct $5,000 in student loan interest, the total amount that would have been available to the individuals prior to marriage.
Another bill related to student loan interest, the Bank on Students Emergency Loan Refinancing Act, was recently blocked by the Senate. The bill would have allowed federal and private student loan borrowers to refinance to rates set for first-time borrowers: 3.89% for Undergraduate Direct Loans, 5.41% for Graduate Loans, and 6.41% for PLUS Loans taken out by a student’s parents. The majority of outstanding student loans have interest rates fixed from the time they were taken out. While interest rates are historically low right now, at the time most were issued, federal loan rates were at 6.8% or higher.
With total U.S. student loan debts totaling $1.2 million and one-in-three student loans considered delinquent, this topic will continue to generate a lot of interest from consumer advocates and legislators.
By Janet Berry-Johnson, CPA