Are Student Loans Tax Deductible?

Are Student Loans Tax Deductible? loading="lazy"

If you're making student loan payments, you may be able to deduct the interest you pay throughout the year on your tax return. That and mortgage interest are generally the only forms of interest that provide a deduction at tax time.

The deduction on student loan interest is made early on in the tax calculation process as an adjustment to your gross income, so you don't have to worry about itemizing your deductions as you do with other common tax breaks.

There are, however, some limitations with deducting student loan interest. Here's what you need to know before you file your next tax return.

How Do Tax Deductions Work on Student Loans?

The U.S. tax code allows you to deduct up to $2,500 in student loan interest on your tax return every year, depending on how much you paid and your income level. You should receive what's called a 1098-E form from your student loan servicer or lender, which shows how much interest you paid during the year.

To qualify for the deduction, you need to meet the following eligibility requirements:

  • You paid interest on a qualified student loan during the tax year.
  • You're legally obligated to pay interest on the loan.
  • You aren't married and filing separately from your spouse.
  • Neither you nor your spouse (if you're filing jointly) can be claimed as a dependent on someone else's tax return.
  • Your modified adjusted gross income (MAGI) is less than a certain amount, which is determined each year (more below).

The loan itself also needs to meet certain criteria for you to qualify for the deduction:

  • It was taken out to pay qualified higher education expenses for you, your spouse or a person who was your dependent when you borrowed the money.
  • The expenses were incurred for education provided during an academic period for an eligible student.
  • The expenses were paid or incurred within a reasonable period of time before or after you took out the loan.

For the 2020 tax year, the income limit is a MAGI of $85,000 if you're filing on your own and $170,000 if you're married filing jointly. The value of the deduction is gradually reduced as your income gets closer to that limit: If your MAGI is $70,000 or more for single and head-of-household filers and $140,000 or more if you're married filing jointly, you'll begin to see a decreased deduction.

Remember, this is your MAGI, which is lower than your gross income. If you're using tax preparation software or you've hired a professional, they can figure out what your MAGI is for you. If you're filing taxes on your own, you can use a worksheet provided by the IRS.

Additional Tax Breaks for Education

If you're still in school or you're saving for or paying qualified education expenses for a spouse or dependent, you may also be eligible for other tax breaks. Here are the three most common ways to save on taxes with education.

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC) allows you to claim a credit of up to $2,500 for qualified education expenses—that's 100% of the first $2,000 and 25% of the next $2,000 spent.

Unlike a deduction, which reduces your taxable income, a credit is a dollar-for-dollar reduction of your actual tax bill. You can only get the AOTC for the first four tax years for each eligible student, which typically covers just an undergraduate degree.

If you don't owe taxes, 40% of the credit is refundable, meaning you can get it in the form of a tax refund.

But like the student loan interest deduction, there are some limitations, so do your due diligence and read about the credit to make sure you qualify.

Lifetime Learning Credit

The AOTC only lasts for the first four years of your higher education. But what if you continue on to graduate school or other programs? This is where the Lifetime Learning Credit (LLC) comes into play.

The LLC offers a 20% credit on the first $10,000 you spend on qualified education expenses, up to $2,000. So it's not as generous as the AOTC. Also, no portion of the credit is refundable, which makes it less appealing if you have the choice between the two.

That said, there's no limit to the number of years you can claim it, so it's perfect if you've already exhausted your AOTC claims. Read about the LLC to find out if you're eligible and how much you can claim.

529 Plan

If you're saving for future education expenses, either for yourself or one of your children, a 529 plan is one of the best ways to do it. Not only does it allow your funds to grow tax-free, but it may also give you an upfront tax break on your state tax return.

According to Saving for College, several states offer some form of a tax break or deduction on your contributions to a 529 plan. It's also important to note that distributions from the plan are tax-free as long as you use them for qualified education expenses.

How to Pay Off Your Student Loans Faster

Getting a tax break on your student loan interest is nice, but paying less interest will give you an even better return on your efforts. Depending on your situation, there are several ways to pay off your student loans faster. Here are just a few:

  • Make interest-only payments while you're still in school.
  • Make additional payments every month.
  • Pay half of your monthly payment every two weeks.
  • Consider refinancing your student loans at a lower rate and possibly a shorter repayment term.
  • Set up automatic payments (some lenders offer an interest rate discount if you do).
  • Look for ways to earn extra money that you can use to pay down your balance faster.

There's no single best approach to paying down student loan debt, so research all of your options to find the best strategy for you.

Pay Student Loans on Time to Build Credit

If you're a recent college graduate, you may not have had time to start building a credit history. Making your student loan payments on time every month can help you build a positive payment history, which is the most important factor in your FICO® Score .

Even if you've been out of school for a while or you're a parent of a student, on-time payments will make it easier for you to build and maintain a good credit history.

Check your credit score throughout the repayment process to keep track of your progress, and look for opportunities to address potential concerns as they arise.