Hey everyone, Joe Gormley, CPA here to answer your tax questions. Do you live near Rutgers? Are you a fan of the Scarlet Knights? Even if you’re a fan of other great colleges, we can all agree that we’re not fans of paying more taxes this year! This is especially true for student loan interest paid by parents. Did you know that those pesky loans can actually help save you money? The Internal Revenue Service understands the financial burden put on parents who wish to send their children to institutes of higher education institutes. In this article, we’ll take a look at how this process works and what can be expected from deducting student loan interest from your taxes. After we’re finished, we’ll be providing links so you can Find a Tax Preparer to advise you on how to get the biggest savings.
It used to be that if parents made payments on a student loan incurred by their children, neither the parents nor the children were eligible for a tax break. To be eligible in the past, the law had said that both parties were liable for the debt without any assistance come tax time. Luckily there’s now an exception to these rules: If the parents help pay back the loan, the IRS treats this shifting of income as those it were a monetary gift to their children. Parents who qualify can deduct up to $2,500 of student loan interest. The catch, however, is that the child must not be claimed as a dependent. Seems fair, no?
First, your lenders are required to send you Form 1098-E if you have paid at least $600 in interest throughout the year. If the same lender provides several student loans, the financial institution applies the $600 to the total of all loans. Be aware that you may get a separate Form 1098-E for each loan, but the limit stays the same. To know how much you’ve paid in student loan interest throughout the year, look at box 1 of Form 1098.
The deductions for student loan interest are taken as an adjustment to calculating your adjusted gross income (AGI). The benefit to this is that for those are choosing a standard deduction; you aren’t required to itemize your deductions.
To determine if you qualify for student loan interest deductions, the interest payments made during the year are required to be taken out for yourself, your spouse, or your dependents for school. There are exceptions, however. For married couples that are filing their taxes separately, they do not qualify. Also, if your modified AGI (known as MAGI) is $80,000 or more if filing as “single” and $160,000 for married filing jointly are also disqualified from this deduction. To determine your MAGI, take your total income minus other adjustments you’ve taken, minus tuition, student loan and domestic production activities deductions. To know if you qualify, it may take a qualified Tax Preparer to determine your eligibility.
If you are determined eligible to make deductions for student loan interest, you will need to put information on Form 1040 to write it off. It is essential to gather all of your 1098-E forms from all of the institutions that provide you with student loans so you can deduct the entire amount due to you. In addition to the interest on student loans, you can add interest you’ve also paid on other qualifying loans. Still, the maximum doesn’t change, with $2,500 being the limit.
If you notice that box 2 of Form 1098-E is checked, this means that the amount reported in box 1 doesn’t have loan origination fees or capitalized interest added into. However, don’t be too confused by this, as usually only loans that were taken out prior to September 1st, 2004 fall into this category.
Just for reference, an origination fee from loans is a percentage of the loan withheld from disbursed funds. It should be noted that you can include a portion—not the entirety—of this fee as deductible interest. To calculate the amount you can treat as student loan interest each year that these fees incur, divide the origination fee by the amount of years remaining to pay off the loan. As an added caveat, if the lender increased the principal loan balance (or capitalized) for unpaid accrued interest, the portion that is deductible can be calculated by the same method to determine origination fees.
Joseph J. Gormley CPA