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Student loan interest: Can tax law keep up?

It’s been termed a crisis and the numbers bear that out. In the first quarter of 2019 student loan debt reached an all-time high of $1.4 trillion. In the last ten years the amount of student loan debt has increased by 116%. There has been a great deal of discussion regarding student loans and various proposals to reduce or even cancel student debt.  Americans carry an average of $35,359 in student loan debt. Student loan debt is only surpassed by mortgage loans and there are approximately 148 million outstanding student loan accounts. We all know that borrowing money isn’t free and for all the outstanding debt there is interest that is paid. Is there any kind of relief for these student loan borrowers? The answer when it comes to taxes is well maybe.

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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. 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 remains under existing tax law and can be taken regardless of whether you itemize your deductions.

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 beginning in 2001.  The maximum deductible amount has remained at $2,500.   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 a dependent 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 program leading to a degree, certificate or other recognized educational credential.  Eligible educational institutions include colleges, universities, vocational schools and other post-secondary educational institutions eligible to participate in the federal student aid program.  Institutions conducting internships or residency programs leading to a degree or certificate awarded by an institution, hospital, or health care facility offering postgraduate training also qualify.  A list of institutions eligible for the federal financial aid program can be found on the U.S. Department of Education’s Federal Student Aid website at www.fafsa.ed.gov
  • The deduction is phased out for taxpayers with Modified Adjusted Gross Income (MAGI) between $70,000 and $85,000 if single or head-of-household, and $140,000 to $170,000 if married filing jointly.

The taxpayer legally obligated to make the interest payments under the terms of the qualified education loan is the only taxpayer eligible for the education loan interest deduction. It is important to verify who the borrower is-the parents or the student. The student is generally the borrower under many federal education loan programs such as Stafford loans whereas PLUS loans are made to the student’s parents.

The deduction for interest paid on a home equity loan was eliminated by the TCJA unless the proceeds were used to acquire or substantially improve the taxpayer’s home that secures the loan. If you borrowed funds on a home equity loan for the sole purpose of paying higher education costs you are eligible to deduct interest up to the maximum $2,500 as student loan interest if the loan is certified as an education loan. A borrower makes the certification by completing Form W-9S and delivering it to the lender. The loan proceeds must be used solely to pay qualified educational expenses so if any of the loan proceeds were used for other expenditures the loan will fail to qualify as an education loan.

The debate surrounding the student loan crisis will undoubtedly continue and as it does the amount of debt is likely to continue to increase. The deduction for student loan interest paid has by all accounts not kept pace with the increase in borrowing. Despite proposals in recent history to eliminate the deduction it remains in effect for taxpayers thus providing albeit small, some relief.

Contact us with any questions you may have on student loans and taxes.

Henry+Horne

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