How much student loan interest is deductible?

Student Loan Interest DeductionAs we approach tax season,  trying to find the best ways to deduct student loan interest should, discover the best tax filing method and review your loan repayment method should be considered along with taxes due.  The question is how much student loan interest is deductible?  One issue that many borrowers face is finding the best way to file their taxes while also trying to minimize their student loan repayment.  With more than 54% of student debt dollars being repaid using an Income-Driven Repayment, a person or couples tax filing decision is much more important and often not reviewed by the tax advisor. 

Since 2016, more student loan borrowers are using the Income-Driven Repayment (IDR) methods such as Income-Based Repayment (IBR), Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE).  With this change, the traditional loan repayment strategies also changed.  By using the IDR method, the taxpayer needs to do some additional tax planning. The IDR methods use a borrower’s Adjusted Gross Income (AGI) to determine the amount they will be paying which is directly related to their income and how they file their taxes.

This is especially true for married couples since they could have up to 126 different student loan repayment and tax filing options if they both have federal loans.  If you were married last year or if one of the spouses needs to start repaying their student loan, a proper tax analysis is highly recommended.  We suggest a full review of your loan repayment options with the various tax filing 

As you can see with the chart below, a simple adjustment in a couple’s tax filing status, debt structure, and income management can result in a significant change in the student loan monthly payment.  The Tax advisor’s focus is to lower your tax burden and may not understand the impact of how the Income Drive Repayment methods are affected.

Student Loan Interest Deduction Phases Out

There is a phase-out of this deduction based on how a person or couple files their taxes and their income.  The student loan interest deduction was originally on the cutting block under the initial tax reform act that started in 2018.  The deduction was maintained which will be a big help for many citizens.

A borrower’s tax filing status will determine when that phase-out begins.  This deduction uses a person Modified Adjust Gross Income (MAGI) to determine if you qualify.  It also adds back a few additional tax exclusions that most borrowers will not have as listed below:

  • Foreign Earned Income Exclusion
  • Foreign Housing Exclusion
  • Foreign Housing Deduction
  • Income Exclusion for residents of American Samoa and Puerto Rico

The table below is the income limits to qualify for the student loan interest deduction based on a person’s or couples’ MAGI for the 2018 taxes.

If a couple or one of the spouses is using an IDR repayment method, you will need to take an additional step that most people do not do.  As you can see from the first chart, monthly payments can change significantly.  You need to compare your AGI number and the impact it may have on your student loan repayment.  The tax advisor’s job is to lower your taxes.  That goal could be contradictory to lowering your monthly student loan payment in many cases.  Properly managing the borrower’s AGI could result in hundreds of dollars a month is a lower payment.

Let’s review this by tax filing options and student loan repayment impact.  The tax filing and repayment options are only available if a borrower has federal student loans.

Single, Head of House Hold and Qualified Widow

In each of these cases, the tax filing status will have no impact on student loan repayment.  The Qualified Widow is the exception and only if the surviving spouse has outstanding student debt.  In that case, they may want to contact their loan servicer or weigh their other tax filing options to manage their AGI better.

Married Filing Joint

A couple filing married and joint will still qualify for the student loan interest deduction.  The problem they may face is with their IDR repayment.  If both have federal loans, the income for the IDR repayment will be based on the percent of total federal loans by each borrower times the joint AGI.

If only one borrower is using an IDR method, this will make the payment much higher.  Evaluating the filing married and separate should be reviewed to see if the increase in tax will offset the monthly repayment amount.

Filing Married but Separate

By filing married but separate, the couple will generally be paying a higher tax than filing married and joint for a variety of reasons.  Regarding the student loan interest deduction, this will disqualify either of the filers to the deduction.

There could be a significant advantage to filing your taxes this way when it comes to loan repayment.  If one of the spouses in using an IDR method, then only their AGI number will be used to calculate their loan repayment method.  Here is where the borrower needs to be more aware of their situations and options.

In most cases, the tax advisor will not ask you the additional question or see the impact of filing your taxes this way.  The PayForED Repayer provides the borrower with this additional analysis so the proper interpretation and decision can be made.

Recent Married

For people married in the prior year and will be filing their taxes for the first time as a couple, a full review should be done by a tax professional.  This is especially true if either of the spouses has federal loan repayment under the IDR methods.

A big mistake many couples make is not correctly analyzing their options.  There is a significant drop off in people qualifying for Public Service Loan Forgiveness after year 3 and 4.  It is my opinion this occurs for a few reasons.  One is their income goes up faster, and they do not qualify any longer.  Another reason is the correlation in the age of the couple getting married and filing their taxes jointly.  Filing their taxes jointly raises their incomes and repayment becomes higher.

Tax Advice Summary

As you can see, the student loan interest deduction is not as easy as it appears.  The tax advisor’s goal is to lower a person’s or family’s taxes.  Many tax advisors do not understand student loan repayment, especially the Income-Driven Repayment methods.  Borrowers need to take the extra steps for yourselves to both lower their taxes and their loan repayments at the same time.  The PayForED Student Loan Repayer calculates both the loan repayment options and the impact of the taxes under each scenario.  With this information, people can make informed decisions and improve their financial future.  If you need professional advice, PayForED does have a list of College Funding and Student Loan advisors.

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