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What You Need to Know about Student Loan Interest

You can claim a deduction for student loan interest whether you claim the standard deduction or you itemize your deductions since it is an adjustment to income.  If you are planning to finance a college education for yourself or a family member it's important to know the rules so that you get the maximum benefit allowed.

If you are considering borrowing funds to finance your college education or that of your spouse or children, it is important that you understand that the student loan interest deduction is not limited to the interest paid on government student loans. In fact, virtually any loan interest will qualify as long as the loan proceeds are used solely for qualified higher-education expenses (that is, it is a sole-purpose loan). However, the maximum interest that is deductible each year is $2,500. Thus, in addition to government student loans, home equity lines of credit, personal loans from unrelated parties and even credit cards can be used if they otherwise qualify. Pension plan loans and loans from related parties do not qualify.

Example #1 – Jack takes out an equity line of credit on his home and borrows $30,000 to finance a solar electric installation on his home and $10,000 to pay his daughter’s qualified education expenses. Because this loan is not used for a single purpose (he used it to borrow funds for more than education), he cannot deduct a portion of the interest as above-the-line education loan interest. However, Jack can still deduct the prorated interest on the solar installation as home-acquisition debt if the total debt does not exceed the acquisition debt limits. If Jack had only used the loan to pay for qualified education expenses, then up to $2,500 of the loan interest could have been deducted as above-the-line student loan interest. 

Example #2 – Mark has a Visa card that he uses for a variety of purposes, and he also uses it to pay his daughter’s qualified education expenses. Because the credit card is not used exclusively to pay for qualified education expenses, none of the interest will qualify as student loan interest. However, if Jack had only used the credit card to pay for qualified education expenses, then up to $2,500 of the credit card interest could have been deducted as above-the-line student loan interest. Caution: although we use a credit card as an example of an alternate student loan, it is not practical because of the high interest rates. 

If a loan is not subsidized, guaranteed, financed, or otherwise treated as a student loan under a program of the federal, state, or local government or an eligible educational institution, a payee (the lender) must request a certification from the payer (the borrower) that the loan will be used solely to pay for qualified higher-education expenses. Form W-9S, Request for Student’s or Borrower’s Social Security Number and Certification, is provided by the IRS for this purpose.

You can claim a deduction for student loan interest whether you claim the standard deduction or you itemize your deductions since it is an adjustment to income, often referred to as an above-the-line deduction. 

To qualify as an eligible loan, the loan must have been taken out solely to pay the costs of attending an eligible educational institution for an individual during a period when the individual is a qualified student. Eligible costs include:

  • Tuition
  • Fees
  • Room and board
  • Books and equipment
  • Other necessary expenses including transportation

The expense must be incurred within a reasonable time before or after the debt is incurred. The regulations provide that a loan is incurred within a reasonable period if:

  • The expenses are paid with the proceeds of a loan from a federal post-secondary education loan program  
  • The expenses are related to a particular academic period and the loan proceeds used to pay the expenses are disbursed within a period that begins 90 days prior to the start of, and ends 90 days after the end of, that academic period. A home equity line of credit can be used to meet these requirements by paying education expenses as they become due, provided that the loan is not used for any other purpose

Such expenses must be reduced by the following:

  1. Income excluded from employer-provided educational assistance
  2. Income excluded from U.S. savings bonds used to pay higher-education expenses
  3. Nontaxable distributions from Coverdell ESAs
  4. Scholarships, allowances, or other payments such as distributions from College 529 plans that are excludable from gross income

Eligible educational institutions –  These are colleges, universities and vocational schools eligible to participate in the Department of Education’s student aid programs, in other words, virtually all accredited public and private post-secondary schools. In addition, institutions conducting internship or residency programs leading to degrees or certificates awarded by a higher education institution, a hospital, or a healthcare facility that offers postgraduate training also qualify.

Eligible student – A student is eligible if they are enrolled in a degree or certificate program and are at least a half-time student. What constitutes half the normal course load will be determined by the definition of the school attended. Generally, a full-time student is one carrying at least 12 credit hours. 

Who Claims the Interest – The above-the-line interest deduction may only be claimed by a person who is legally obligated to make the payments on the qualified educational loan. However, tax regulations allow payments on above-the-line education interest made by someone other than the taxpayer/borrower to be treated as a gift, allowing the interest to be deductible by the taxpayer. 

Not Available to Higher-Income Taxpayers  The deduction is ratably phased-out for taxpayers with an AGI (income) of $70,000 to $85,000 ($140,000 to $170,000 for joint returns) and not allowed at all for taxpayers filing as married separate or an individual who is a dependent of another. The amounts shown are for 2019.  You may contact this office for deductible amounts for other years.

If you are considering borrowing money to pay for higher-education expenses, it may be appropriate to consult with Hippo Tax Services since there may be other limitations. 

Please check with your tax advisor, your Curran Wealth relationship manager,
 or contact Curran Wealth Management if you have any questions.

The material contained in this article is for educational and informational purposes only.  The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness.  This article is not, and should not be regarded as “investment advice” or construed as a “recommendation” or an offer to buy or sell a security.  The information contained in this article may not apply to your personal circumstances.  Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation.  Information on taxes is based on the tax laws existing at the time of publication.  Tax laws are subject to continual change.  In addition, tax laws vary by state.  This article is not, and should not be regarded as tax or legal advice.  We cannot ensure tax consequences of any transaction.  If you would like a detailed analysis of your tax situation, with specific tax recommendations, you can discuss the possibility of pursuing a formal relationship with Hippo Tax Services.