The Taxpayer Relief Act of 1997 restores the deduction for interest paid on student loans. These new tax breaks can significantly reduce the cost of repaying loans issued under the Federal Family Education Loan Program, but do come with a few strings attached. The following Q&A has been prepared to help answer general questions on how borrowers can take advantage of the student loan interest deduction, and if they are eligible to take this deduction. Clearly, their ability to claim this tax break depends on their individual circumstances. To determine whether they can benefit from the deduction, borrowers are urged to consult a qualified accountant or tax adviser.
Questions & Answers
Q: Just how much interest can borrowers deduct?
A: The Maximum deduction is $2,500. Under the statue, the limit will not be adjusted to take into account the effects of inflation.
Q: Who is eligible to take the deduction?
A: In general, the deduction is available to any borrower with a qualified education loan who meets the required income test. The borrower may be a student or the parents or spouse of the student whose studies are funded by the loan. A student cannot file for the deduction if he or she is claimed as dependent on parents’ tax returns. A married borrower must file a joint tax return to claim deduction
Q: What are the income limits?
A: The government applies different income limits, depending on the borrower’s marital status. The income limits takes into account the borrowers adjusted gross income.
Single borrowers who report adjusted gross incomes of $40,000 or less will be able to take the full deduction. The deduction will be phased out for single taxpayers earning $40,000 to $55,000. Those earning $55,000 or more will not be eligible to deduct any student loan interest.
Many, if not most, single college graduates can expect to qualify for the deduction, in full or in part. According to the annual starting salary survey conducted by the National Association of Colleges and Employees, members of the class of 1997 typically can anticipate job offers ranging from $23,000 to $44,000.
Married taxpayers who report incomes of $60,000 or less can take the full deduction. The deduction will gradually reduced for couples reporting annual adjusted gross incomes of $60,000 to $75,000. The interest deduction is not available to married taxpayers who earn $75,000 or more a year.
Q: Will the income limits be adjusted for inflation?
A: Yes, But the new law stipulates that adjusted income level must be rounded down to the nearest multiple of $5,000.
Q: What loans qualify for the deduction?
A: A loan is eligible if the proceeds are used to fund direct higher education expenses.
These expenses are limited to tuition, fees, books, equipment, and room and board.
Eligible loans would include:
Federal Stafford Loans
Federal PLUS Loans
Federal and Direct Consolidation Loans
Federal Perkins Loans
Loans issued under the federal loan programs for health care professionals
Education loans issued by banks and other private lenders
Loans issued to students or parents by schools
Q: What about home equity loans?
A: Interest on home equity loans or home equity line of credit is already deductible, subject to certain limits.
Taxpayers who claim the home equity deduction cannot deduct this interest under the student loan deduction.
Q: Are there any loans that are not eligible?
A: Borrowers cannot deduct the interest they pay on personal loans they receive from a relative.
Q: Does the taxpayer have to itemize deductions to claim the student loan deduction?
A: No. Borrowers will be able to claim the deduction whether or not they itemize their deductions. Tax filers who use the short form will be able to deduct their student loan interest payments.
Q: Is there a limit on how long a borrower can claim the deduction?
A: Yes. Subject to the income test, a borrower may deduct the interest portion of loan payments made on or after January 1, 1998 provided that the borrower is still in the first 60 months of repayment.
Q: Can a borrower renew the deduction eligibility by consolidating his or her loans?
A: No. Any months spent in repayment before the borrower’s loans were consolidated will count toward the 60-month limit for the deduction. Consider for example a borrower who begins repayment of $20,000 in Stafford loans in January 2002, but two years later consolidates the remaining balance of the loans. The borrower will be able to deduct the interest paid on the unconsolidated loans in 2002 and 2003. In addition, the borrower will be able to deduct the interest paid on the consolidated loan during the years 2004, 2005 and 2006.
Q: How will the lender know how much interest to deduct each year?
A: Lenders will be required to provide borrowers with an annual statement.
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