Is The Student Loan Interest Tax Deduction Really Helping You?

CNN Money reports over 40 million Americans have student loan debt. Whether you’re one of these folks or not and with all the talk of a “looming student debt crisis” it’s important to know about the student loan interest tax deduction. Luckily this isn’t one of the more complicated tax laws but it affects many more than just those with debt - youngsters looking to go to college, folks considering going back to school, families starting to plan for their children’s education and so on. With that, here’s what I think everyone should know about the student loan interest deduction.

How much is the deduction?

The smaller of: (a) $2,500 and (b) the amount of interest paid during the year. However, if you start to make to make too much money your deduction can be reduced down to zero - called “phasing out.” IRS phase out table can be found here: (https://www.irs.gov/publications/p970/ch04.html#en_US_2015_publink1000178272) but to put it simply: if you’re single and make more than $80k you cannot get a tax break; $160k if you’re married filing jointly.

Food for thought: According to the Pew Research Center in 2009 the median monthly income for households headed by 25-34 year olds with a Bachelor’s degree was $7,232/mo or $86,784/yr meaning a large chunk of those people would not get any tax deduction if they had student loans needed to get their degree. (See actual report for study disclaimers).

Second helping: the WSJ reports over 40% of Americans are not currently paying down their student loans. No payments > no interest paid > no tax deduction > an inefficient tax policy.

Who can claim it?

The requirements are pretty clear cut so to keep this short let’s assume if you got a Form 1098-E you’re eligible. If you didn’t get a 1098-E consult a CPA before claiming the deduction.

The more useful question is who isn’t eligible. Those are: (a) if you’re married filing separately or (b) if someone else is claiming you as a dependent (i.e. parent or guardian.)

Tip for students: if you file your own tax return check to see if your parents are claiming you as a dependent. If so, they would be the ones to get the student loan interest deduction (even if you made the payments.) If not, you’re good to go.

Final thought

In my opinion this deduction is nice in theory but poorly executed. For one, if you can even take the deduction the benefit you receive is rather small compared to how much debt you may have. At best it equals ‘$2,500 times your effective tax rate’ which let’s say for the sake of an example is 20%. That’s a savings of only $500 on loans that could be tens or even hundreds of thousands of dollars. That’s not much of an incentive to get a degree. And higher educated people are usually higher earners that may not get the tax benefit at all so this deduction is even less effective. All things to consider in our journey to learn about personal taxes.


(General blog disclaimers apply to this article. Consult a CPA. Views expressed in this article are mine alone.)