Student Loan Interest Deduction

If you paid interest on a student loan in 2000, you may be able to deduct up to $2,000 of the interest you paid. You can deduct interest paid during the first 60 months that interest payments are required on the loan.

What is the tax benefit of the student loan interest deduction? The benefit of the student loan interest deduction is that you may be able to reduce the amount of your income that is subject to tax by up to $2,000 in the year 2000 (up to $2,500 for 2001 and later years).

This deduction is taken as an adjustment to income. This means you can claim this deduction even if you do not itemize deductions on Schedule A (Form 1040).

Include as interest. Loan origination fees (other than fees for services) and capitalized interest are student loan interest if all other requirements are met.

Loan origination fees. These are the costs of getting the loan.

Capitalized interest. This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan.

If you pay more than $600 in interest during the year to a single lender, you should receive a statement at the end of the year from the lender showing the amount of interest you paid. That information will help you complete your tax forms.

Who Can Claim the Deduction?

Generally, you can claim the deduction if all of the following requirements are met.

• If you are married, you are filing a joint return.
• No one else is claiming an exemption for you on their tax return.
• You paid interest on a loan taken out only to pay tuition and other qualified higher education expenses for yourself, your spouse, or someone who was your dependent when the loan was taken out.
• The education expenses were paid or incurred within a reasonable period of time before or after the loan was taken out.
• The person for whom the expenses were paid or incurred was an eligible student.
• The first 60 months in which interest payments were required on the loan did not end before January 2000.

Many of the terms used in the above list are explained later in this chapter.

Who Can Claim the Deduction

Married. If you were married on the last day of the year, you are considered married for the entire year. You are not considered married if you are eligible to use the unmarried head of household filing status. More information about your correct filing status can be found in Publication 501, Exemptions, Standard Deduction, and Filing Information.

Claiming an exemption. Another taxpayer is claiming an exemption for you on their tax return if they list your name on line 6c, Form 1040 (or Form 1040A).

Dependent. Generally, a dependent is someone who:

• Receives most of his or her support from you,
• Is either related to you or lives with you, and
• Is a citizen or resident of the United States, Canada, or Mexico.

More information about dependents can be found in Publication 501.

What are Qualified Higher Education Expenses?

Generally, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include the costs of:

1. Tuition and fees.
2. Room and board.
3. Books, supplies, and equipment.
4. Other necessary expenses (such as transportation).

However, you must reduce these costs by the total amount paid for them with the following tax-free items.

• Employer-provided educational assistance benefits. See chapter 7.
• Tax-free withdrawals from an education IRA. However, the tax-free treatment of the withdrawal can be waived. See chapter 4.
• U.S. savings bond interest used to pay qualified higher education expenses. See chapter 6.
• Certain scholarships. See Publication 520, Scholarships and Fellowships.
• Veterans' educational assistance benefits.
• Any other nontaxable payments (other than gifts, bequests, or inheritances) received for educational expenses.

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.

For purposes of the student loan interest deduction, the term also includes an institution conducting an internship or residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers postgraduate training.

The educational institution should be able to tell you if it is an eligible educational institution.

No double benefit allowed. You cannot deduct as interest on a student loan any amount you can deduct under any other provision of the tax law (for example, home mortgage interest).

What Is A Reasonable Period of Time?

Qualified higher education expenses paid with the proceeds of education loans that are part of a federal post-secondary education loan program meet the requirement of being paid or incurred within a reasonable period of time before or after the loan is taken out.

For other loans, the reasonable period of time usually is determined based on all the relevant facts and circumstances. However, see Reasonable period safe harbor, next.

Reasonable period safe harbor. Qualified education expenses are treated as paid or incurred within a reasonable period of time before or after the debt is incurred if:

• The expenses relate to a particular academic period, and
• The loan proceeds are disbursed within a period that begins 60 days before the start of that academic period and ends 60 days after the end of that academic period.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution.

Who Is An Eligible Student?

An eligible student is a student who was enrolled at least half-time in a program that leads to a degree, certificate, or other recognized educational credential.

Enrolled at least half-time. A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.

The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than standards for half-time established by the Department of Education under the Higher Education Act of 1965.

Student Loan Interest Deduction at a Glance

First 60 Months

Regardless of when you took out the loan, you can only deduct the interest paid during the first 60 months that interest payments are required.

No deduction is allowed for interest payments due or paid before 1998.

Beginning of 60-month period. The date the 60-month interest deduction period begins is based on:

• The terms of the loan agreement, or
• Applicable federal regulations, if the loan was issued or guaranteed under a Federal post-secondary education program.

The 60-month period continues to pass whether or not the required interest payments are actually made. However, the 60 months may or may not be consecutive. For more information, see Suspension of 60-month period, later.

Effect of refinancing. Generally, the refinancing of a student loan has no effect on the 60-month period. All refinancings of a student loan are the same loan for the purposes of determining the 60-month period. A refinanced loan has the same 60-month period as the original loan. See Consolidated loan and Collapsed loans, next.

Consolidated loan. This is a loan that refinances more than one student loan of the same borrower. The 60-month period for a consolidated loan begins on the most recent date on which interest payments became due on any of the refinanced loans.

Collapsed loans. These are two or more loans of the same borrower that are treated by both the lender and the borrower as one loan. The 60-month period for a collapsed loan begins on the most recent date on which interest payments became due on any of the separate loans.

Suspension of 60-month period. The 60-month period is suspended for any period of time during which interest payments are not required by the lender. However, the 60-month period is not suspended if, under the terms of the loan both of the following statements are true.

1. Interest continues to accrue (be charged) even though the payments are not required.
2. You keep making interest payments even though you are not required to do so.

If you refinance, consolidate, or collapse a student loan, the new loan can also be a student loan. But refinancing, consolidating, or collapsing a loan does not extend the 60-month period described earlier. The 60-month period is based on the original loan.

Exception. If a student loan was not issued or guaranteed under a federal postsecondary education loan program, the 60-month period is suspended only if the borrower meets certain conditions. Those conditions include:

• Half-time study at a postsecondary educational institution,
• Study in an approved graduate fellowship program,
• Study in an approved rehabilitation program for the disabled,
• Inability to find full-time employment,
• Economic hardship, and
• The performance of services in certain occupations or federal programs.

Example. You took out a student loan in 1993. You made a payment on the loan every month, as required, beginning October 1, 1995. You can deduct the interest on your first nine payments for 2000. You cannot deduct the interest on any later payments because they are after the 60-month period (October 1, 1995 - September 30, 2000).

Who Cannot Claim the Deduction?

You cannot claim a deduction for student loan interest if any of the following apply.

• Your filing status is married filing a separate return.
• You are a dependent for whom an exemption is claimed on the tax return of another person.
• The interest was paid on a loan from a related person.
• The interest was paid on a loan from a qualified employer plan.

Dependent for whom an exemption is claimed. You are a dependent for whom an exemption is claimed on another person's tax return if another taxpayer lists your name on line 6c of their Form 1040 (or Form 1040A).

Loan from related person. You cannot deduct interest on a loan you get from a related person. Related persons include your brothers and sisters, half brothers and half sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Related persons also include certain corporations, partnerships, trusts, and exempt organizations.

Loan from a qualified employer plan. You cannot deduct interest on a loan made under a qualified employer plan or under a contract purchased under such a plan.

How Is the Deduction Figured and Reported?

Your student loan interest deduction for 2000 is generally the smaller of:

1. $2,000, or
2. Your interest payments that were both:
   1. Paid in 2000, and
   2. Paid during the first 60 months that interest payments were required.

However, the amount determined above may be phased out (gradually reduced) or eliminated based on your filing status and modified adjusted gross income as explained later under Does Income Affect the Amount of Your Deduction?

Maximum Deduction

Your deduction for 2000 cannot be more than $2,000. This limit increases to $2,500 for 2001 and later years.

Does Income Affect the Amount of Your Deduction?

The amount of your student loan interest deduction is phased out (gradually reduced) if your modified adjusted gross income is between $40,000 and $55,000 ($60,000 and $75,000 if you file a joint return). You cannot take a student loan interest deduction if your modified adjusted gross income is $55,000 or more ($75,000 or more if you file a joint return).

The following chart describes the affect the amount of your modified adjusted gross income has on the student loan interest deduction you are allowed to claim.

Phaseout of Deduction

Modified adjusted gross income. For most taxpayers, modified adjusted gross income will be their adjusted gross income (AGI) as figured on their federal income tax return but without the deduction for student loan interest. On Form 1040, AGI is line 33. On Form 1040A, AGI is line 19. However, you must make adjustments to your AGI if you excluded income earned abroad or from certain U.S. territories or possessions. If this applies to you, increase your AGI by the following amounts you excluded from your income.

1. Foreign earned income of U.S. citizens or residents living abroad.
2. Housing costs of U.S. citizens or residents living abroad.
3. Income from sources within Puerto Rico, Guam, American Samoa, or the Northern Mariana Islands.

How the phaseout works. To figure the phaseout, multiply your interest deduction (before the phaseout) by a fraction. The numerator is your modified adjusted gross income minus $40,000 ($60,000 in the case of a joint return). The denominator is $15,000. Subtract the result from your deduction (before the phaseout). This result is the amount you can deduct.

Example 1. During 2000 you paid $800 interest on a qualified student loan. Your 2000 modified adjusted gross income is $67,500 and you are filing a joint return. You must reduce your deduction by $400, figured as follows.

$800 times ($67,500 minus $60,000) divided by $15,000 equals $400:

        $67,500 - $60,000
$800 × ------------------- = $400
             $15,000

You can deduct $400 ($800 - $400).

Example 2. The facts are the same as in Example 1 except that you paid $2,200 interest. Your maximum deduction for 2000 is $2,000. You must reduce your maximum deduction by $1,000, figured as follows.

$2,000 times ($67,500 minus $60,000) divided by $15,000 equals $1,000:

          $67,500 - $60,000
$2,000 × ------------------- = $1000
                $15,000

You can deduct $1,000 ($2000 - $1,000).

How Do You Report the Deduction?

The student loan interest deduction is an adjustment to income. To claim the deduction, enter the allowable amount on line 24 of Form 1040, or line 17 of Form 1040A.

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