Tax forms scattered on top of a messy pile of money.

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Nobody enjoys making student loan payments, but there’s a tax break known as the student loan interest deduction that can make it a little less painful. If you qualify, the deduction can save you hundreds of dollars on your tax bill each and every year, whether you itemize deductions on your tax return or not. With that in mind, here’s what you need to know about this lucrative deduction so you can take full advantage.

The student loan interest tax deduction

Here’s the short version. The IRS allows a deduction of as much as $2,500 of interest paid on qualifying student loan debt per tax year. In other words, if you pay $1,000 in student loan interest during the 2019 tax year, you can deduct the entire amount (assuming you qualify -- we’ll get to that shortly). On the other hand, if you paid say, $4,000 of student loan interest, you can only deduct $2,500 of that amount.

According to the IRS guidelines, all five of the following criteria must be met in order to claim the deduction:

  • You paid interest on a qualified student loan during the tax year -- we already mentioned this one.
  • You are legally obligated to pay the interest on a qualified student loan. In other words, you can’t claim the deduction for interest that someone else (such as your parent) is legally obligated to pay.
  • You don’t use the married filing separately status when filing your tax return.
  • You qualify based on your income, which we’ll discuss in detail in the next section.
  • You (or your spouse) cannot be claimed as a dependent by someone else.

The deduction is designed for low- to middle-income taxpayers

One potential drawback of the student loan interest deduction is that you may not be able to take advantage if you’re a higher-income household. Since the deduction is designed to give a break to student loan debtors of more limited means, the ability to take the deduction is income-restricted.

Specifically, for the 2019 tax year (the return you’ll file in 2020), the ability to claim the student loan interest deduction starts to go away if your MAGI (modified adjusted gross income) is greater than $70,000 for single and head of household filers or $140,000 for married couples filing jointly.

Above these levels, the deduction begins to phase out (reduce). For single or head of household filers with MAGI over $85,000 or joint filers with MAGI greater than $170,000, the deduction disappears entirely.

Here’s an example. Let’s say that you’re single and that you pay $2,500 in student loan interest in 2019. If your MAGI is less than $70,000, you can deduct the entire amount. If your MAGI is between $70,000 and $85,000, you can deduct a partial amount. If your MAGI is greater than $85,000, you can’t use the student loan interest deduction at all.

If you aren’t familiar with the concept of MAGI, here’s a quick description. Adjusted gross income, or AGI, refers to your total, or gross, income, minus certain adjustments, such as deductible IRA contributions. For most taxpayers, MAGI is the same as AGI, although there are a few possible further adjustments.

An above-the-line deduction

It’s also worth noting that the student loan interest deduction can be taken even if you don’t itemize deductions on your tax return. This is known as an above-the-line deduction or adjustment to income, which means that it can be used by all qualified taxpayers, regardless of whether they itemize or not.

What is qualifying student loan debt?

There are two general conditions that need to be satisfied for debt to be considered qualifying student loan debt for the purposes of the student loan interest deduction. The loan needs to meet the IRS’s definition of a student loan, and the proceeds from the loan must have been used to pay qualified education expenses.

Let’s start with the definition of a student loan. For debt to be considered a student loan in the eyes of the IRS, it doesn’t necessarily need to be a student-specific lending product. Rather, the debt must have been incurred for the purpose of paying qualified education expenses for you, your spouse, or someone who was your dependent. Obviously, federal or private student loans can meet this definition, but under the right circumstances, other lending products like personal loans, credit card debt, and home equity loans can meet the IRS definition of a student loan.

You can’t, however, borrow money from a relative and call it a “student loan” for the purposes of deducting interest. Similarly, you can’t borrow from a qualified employer plan and call it a student loan.

Furthermore, the loan proceeds must have been used to pay qualifying education expenses within a reasonable amount of time, which the IRS defines as a loan disbursed between 90 days prior to the start of an academic period and 90 days after its end. In other words, if you take out a loan two months before you started school for the fall semester, that can qualify as a student loan. On the other hand, if you try to say that you paid your fall tuition with money you borrowed two years prior, the IRS is likely to have a problem with that.

Now let’s take a look at what the phrase “qualified education expenses” means. For starters, the student must have been enrolled in a degree or certificate program and must have been taking classes on at least a half-time basis when the expenses incurred. And the student must have been enrolled at an eligible educational institution, which typically means any accredited postsecondary institution.

The expenses that qualify can include tuition, fees, required supplies, books, lab equipment, room and board, and more. For the most part, any expense that is necessary to attend school and complete the required coursework can be considered a qualifying education expense, but room and board is subject to limits based on your school’s published cost of attendance.

What tax documentation do you need?

For most people who paid student loan interest, IRS Form 1098-E, Student Loan Interest Statement, is the documentation you’ll need to have in order to claim the deduction. If you have federal student loans, or have student loans through a private lender, they’ll send you one of these forms shortly after the end of the calendar year.

On the other hand, if you have qualifying student loan debt, but it isn’t technically a “student loan,” an interest statement from your financial institution should be fine. For example, if you took out a personal loan and used the proceeds to help pay qualifying educational expenses, it can be considered student loan debt, and your lender should provide a year-end interest statement -- although you’ll probably need to print one out.

What if your spouse paid student loan interest as well?

One important thing to know is that the $2,500 maximum deduction is per return, not per person. In other words, if you and your spouse both paid student loan interest, you’re limited to a total of $2,500 between the two of you. This is one of several forms of the so-called “marriage penalty” -- in fact, my wife and I took a considerable tax hit after we got married, and the per-return nature of the student loan deduction was largely to blame.

The bottom line on the student loan interest deduction

The student loan interest deduction can help you save hundreds of dollars on your tax bill each year, even if you don’t itemize deductions. Be sure that your loans and expenses qualify, and that you have the proper documentation before claiming the deduction, just in case the IRS decides to take a closer look.