When planning your finances an important detail that should not be overlooked is the student loan interest deduction. Unlike car payments or credit card bills, interest paid towards student loans can be a deduction on your taxes. While this deduction is a nice program, it has a number of limitations that must be considered.
How much student loan interest can I deduct from my taxes?
For the year 2015, the maximum deduction is $2,500. At the end of the year your lender should provide you a copy of your 1098-E. This document will list the exact amount that you spent on interest for the year.
Does a $2500 deduction mean I save $2500 on my taxes?
No. This is a very common misconception. When tax people use the term “deduction” they are talking about “deducting” it from your income, not from what you owe. If you paid over $2500 in student loan interest on a salary of $52,500, your salary in the eyes of the IRS will be reduced to $50,000.
In short, the deduction means that you are taxed on less of the money you earn.
How much can I save with the student loan interest deduction?
Because of the limits that are in place on income, the most an individual can save on their taxes is $625. This number is based upon a tax rate of 25%. While some people do fall in higher tax brackets, their income is too high to qualify for the deduction.
What is the maximum income for the student loan interest deduction?
In order to qualify for the entire deduction, individual income must be less than $65,000 (or $130,000 for married couples). At that point, the student loan interest deduction begins to phase out, meaning people who make above $65,000 can only claim a portion of the deduction. Individuals making over $80,000 (or couples making over $160,000) per year cannot claim the deduction at all.
Can I deduct student loan interest if I don’t Itemize?
Yes. The student loan interest deduction is known as an “above the line” deduction. That means that all taxpayers can take the deduction, not just those who itemize.
Generally speaking, taxpayers have the option of taking the standard deduction, or itemizing all of their deductions. The exceptions to this general rule are called above the line deductions. Student loan interest falls within this exception. Taxpayers can take the standard deduction and the student loan interest deduction.
What happens if I make payments that were not required?
The important detail is the interest. Suppose you are in your 6-month grace period after graduation or on a forbearance. Payments that you make during this time could potentially be applied to your principal balance or towards interest. Payments applied towards interest, even if the payment wasn’t required, can be deducted.
Further Reading: For more detailed information on the student loan interest deduction and how it works, check out the IRS page on student interest.