Everything You Need to Know About Student Loan Tax Breaks

If you have student loans, you can use them to your advantage this tax season. And considering we’re still navigating a health and economic crisis from the COVID-19 pandemic, every dollar counts to ensure you aren’t paying more than needed.

The Internal Revenue Service (IRS) allows borrowers and students to claim certain tax deductions and credits to offset the cost of higher education. But each tax benefit has its own eligibility requirements and tax forms.

Here’s what you need to know about the various student loan tax deductions and credits for the upcoming tax season.

Tax deductions for student loan borrowers and current students

Student loan borrowers and current students (or parents of eligible students) may claim tax deductions to shield a portion of their taxable income. This reduces their overall tax liability.

Available tax deductions include the Student Loan Interest Deduction and the Tuition and Fees Deduction.

Student Loan Interest Deduction

The Student Loan Interest Deduction allows borrowers to deduct interest paid to federal or private student loans each year.

This tax benefit is an adjustment to income, so you don’t have to itemize your taxes to claim it. But you’ll need to meet certain student and loan requirements.

For example, your loan must have been taken out solely to pay for qualified education expenses. And the eligible student (you, your spouse or your dependent) must have been enrolled at least half-time when the loan was taken out.

Other key details of this tax deduction include:

• You can reduce your taxable income by up to $2,500.

• The amount of your deduction depends on your modified adjusted gross income (MAGI). Your tax benefit is gradually phased out once your MAGI hits $70,000 ($140,000 if you file a joint return). And the deduction isn’t available at all to borrowers whose MAGI is $85,000 or more ($170,000 if you file a joint return).

You should receive Form 1098-E from your loan servicer if you made $600 or more of interest payments during the year. This form can be used to help you figure out your student loan interest deduction.

To claim the Student Loan Interest Deduction, enter the amount on Schedule 1 of Form 1040 or 1040-SR.

Tuition and Fees Deduction

The Tuition and Fees Deduction expired in 2017 but was extended through 2020. This means eligible students and parents can claim the deduction for their 2020 tax return, as well as retroactively for 2018 and 2019 tax years.

To be eligible for the tax deduction, you must have paid for qualified education expenses during the tax year for yourself, your spouse or your dependent.

Key details include:

• You can deduct up to $4,000 in qualified education expenses.

• You can’t claim the tax deduction if you’re married filing separately, or if someone else can claim you as a dependent.

• The amount of your deduction depends on your modified adjusted gross income (MAGI). This deduction is subject to a phase out starting at a MAGI of $65,000 ($130,000 if filing joint return). If your MAGI is more than $80,000 ($160,000 if you file a joint return), you won’t qualify for the deduction.

Your school should send Form 1098-T to help figure out your Tuition and Fees Deduction. But the amount listed on the form might not reflect the actual amount you paid in qualifying expenses.

To claim the Tuition and Fees Deduction, complete Form 8917 and submit it with your Form 1040 or 1040-SR.

Education tax credits for parents and students

There are also two tax credits available to help offset the cost of higher education by directly reducing your income tax dollar for dollar.

These tax credits are the American opportunity credit and the lifetime learning credit. And each credit has its own tax incentive and requirements.

The American opportunity credit

The American opportunity tax credit allows taxpayers to claim up to $2,500 for qualified education expenses paid for each eligible student during the first four years of college enrollment.

Key details include:

• The credit is only available for four tax years per eligible student. This time limit includes any years the Hope scholarship credit was claimed.

• It is partially refundable. If you can receive up to 40% of the credit back if your tax liability is zero. But the remaining portion of the credit is non-refundable.

• The amount of your credit depends on your MAGI. The credit is phased out if your MAGI is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return). But you can’t claim the credit once your MAGI is $90,000 or more ($180,000 if you file a joint return).

To claim the American opportunity credit, use Form 1098-T from your school to complete Form 8863. Then submit it with your Form 1040 or 1040-SR.

The lifetime learning credit

Parents and students can lower their tax liability by up to $2,000 when they claim the lifetime learning credit for qualified higher education expenses.

This credit has no limit on the number of years it can be claimed for each student. But it must be used for tuition and related expenses that are required for enrollment at an eligible educational institution (e.g. college or vocational school).

Key details for the lifetime learning credit include:

• The credit is 20% of the first $10,000 of qualified education expenses you paid. The maximum amount you can claim is $2,000.

• It’s a nonrefundable tax credit. The credit can be used to help pay any taxes you owe, but you won’t receive a refund for any of the unused credit.

• The amount of your credit you can claim is based on your MAGI. The amount is phased out if your MAGI is between $58,000 and $68,000 ($116,000 and $136,000 if you file a joint return). And the credit isn’t available to taxpayers with a MAGI of $68,000 or more ($136,000 if you file a joint return).

To claim the lifetime learning credit, complete Form 8863 and submit it with your Form 1040 or 1040-SR.

Weighing your options

It’s important to note that you can’t claim both credits for the same student in the same year — even if you’re eligible for both tax credits. Nor can you claim a lifetime learning credit or American opportunity credit in the same year that you claim a tuition and fees deduction for the same student.

So, you’ll need to weigh each tax credit and deduction to determine which one is most advantageous to your taxes each year.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes