According to a recent survey by Student Loan Hero, 77% of student loan borrowers know that student loan interest is tax deductible. This leaves 23% of Americans with student loan debt who don't know they can deduct their student loan interest whether they itemize deductions or not, an oversight that could cost them hundreds of dollars every year.
Equally as surprising, about a third of those who said they didn't know about the deduction file their taxes with a software program or app, which usually prompt users to deduct their interest (maybe they think you need to itemize deductions to take advantage).
Whatever the reason for the lack of awareness, overlooking this excellent tax break could be a costly error for borrowers. In the 2015 tax year alone, about 12.5 million borrowers claimed student loan interest deductions totaling about $13.6 billion.
Image source: Getty Images.
The student loan interest deduction
In a nutshell, the IRS allows you to deduct up to $2,500 in student loan interest per year that you paid toward qualified student loans. You can deduct any interest you paid, up to this maximum, even if you weren't required to pay it during the year. For example, many borrowers' required monthly payments under the Pay As You Earn repayment plan don't even cover the interest that accumulates on their loans. So, even if you paid interest beyond your required payments, it's still eligible.
To claim the deduction, you must be legally obligated to pay the interest on the loan(s) in question, meaning that it must be a loan in your name. You also cannot file as married filing separately, and you and your spouse, if applicable, cannot be claimed as dependents on someone else's return.
Furthermore, the student loan interest deduction is subject to income limitations. Currently, to claim the deduction, your modified adjusted gross income (MAGI) must be less than $80,000 if you file as single or head of household, or $160,000 if you're married and filing a joint return.
A qualified student loan is one that you took out to pay higher education expenses for you, your spouse, or a dependent, and the expenses must have been incurred and/or paid within a reasonable amount of time. In other words, you can't take out a loan, pay tuition five years later, and call it a qualified student loan.
If you paid at least $600 in student loan interest during the year, your lender will send you a Form 1098-E. If your interest was less than $600, you can find it by logging into your loan servicer's website, or by calling them.
The best part for most taxpayers
Perhaps the best part of the student loan interest deduction is that you can take it regardless of whether or not you itemize deductions. It's known as an "adjustment to income," and therefore is considered before you need to choose your deduction method. Since 70% of all taxpayers choose the standard deduction, this should come as welcome news to many student loan borrowers.
How much could it save you?
Your tax savings from the student loan interest deduction depends on your marginal tax rate for the year, aka your tax bracket. However, for a taxpayer in the 25% bracket who pays more than $2,500 in student loan interest, the deduction could put $625 back in their pocket every year for as long as they're paying back their qualified student loans.
