Availing education from the famous universities in the USA nowadays has become very costly. Hence, many of them apply for student loans so that they can complete their higher education and pursue the career of their choice.
Under Topic 456, the Internal Revenue Service (IRS), an official department of the Government of America, has prescribed a limit. A student can deduct $2,500 or the amount of interest, whichever is lower for the year. You can claim a student loan interest deduction on IRS Form 1040.
Eligibility Criteria for Availing Student Loan Interest Deduction:
You paid interest on a qualified student loan in the tax year 2021.
When you are legally bound to pay interest on a qualified student loan,
Your modified adjusted gross income (MAGI) is less than a specified amount, i.e., your MAGI should be between $70,000 - $85,000 (if the return is filled out individually) and $1,40,000 - $1,70,000 (if the return is filed jointly).
Qualified Student Loans & Qualified Higher Education Expenses (as defined in IRS Form 1040, Line 21):
Qualified Student loan
When an individual takes any loan to pay for expenses which are related to a qualified student loan, for any of the people mentioned (yourself or your spouse; person who was dependent on you or any person whom you could have claimed as a dependent for that year when the loan was taken), then such a loan is called a qualified student loan.
Exception: If the person who has filed a joint return had gross income that was equal to or more than the exemption amount for that year, or $4,300 for 2021, you, or your spouse if filing jointly, could be claimed as a dependent on someone else's return.
Qualified Higher Education Expenses
Expenses like tuition, fees, room and board, or expenses included for purchasing books or other stationery items are generally called qualified higher education expenses.
These expenses must be used for education in a degree, certificate, or similar program at an eligible educational institution.
Worksheet 4-1 for Student Loan Interest Deduction as Per Schedule 1, Line 21
You should also make the following adjustments Qualified Education Expenses -
You must reduce certain tax-free items from the total amount paid:
The employer has provided any educational assistance for higher education
Tax-free distribution of earnings from a Coverdell education savings account (ESA) and a qualified tuition program (QTP).
U.S. savings bond interest is excluded from income.
The tax-free part of scholarships and fellowship grants.
Veterans' educational assistance.
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
Phaseout -
If the MAGI is within the range of incomes where the credit must be reduced, you must figure out your reduced deduction.
Examples:
In 2021, you paid $1,000 interest on a qualified student loan. Your 2021 MAGI is $80,000/$1,65,000. and you are filing a joint return. You must reduce your deduction by $400 (if you are an individual) and $833.33 (if you fill joint return).
Case 1: If your MAGI is $80,000, multiply $1,000 by [($80,000-$70,000)/ $15,000] to get $666.67 (rounded off to two decimals).
Case 2: If your MAGI is $1,65,000, multiply $1,000 by [($1,65,000-$1,40,000)/$30,000] to get $833.33 (rounded to two decimals).
If you paid interest on more than $3,000, you can deduct up to $2,500, and the rest is taxable.
What is the effect of modified adjusted gross income on student loan interest deduction?
Let’s understand the effect of MAGI in the following tree diagram –
You cannot claim double benefits:
No deduction is allowed as interest on the student loan amount if
Deduction of any interest is allowed under any other provision of the law.
The amount paid from the distribution of earnings made from a qualified tuition programme (QTP) after 2018 to the extent the earnings are treated as tax-free.
Interest is paid by your employer under an educational assistance programme after March 27, 2020, and before January 1, 2026.
Form 1098- E
To help one figure out the student loan interest deduction, one should receive a Form 1098-E, Student Loan Interest Statement. Generally, an institution (such as a bank or governmental agency) that received interest payments of $600 or more during 2021 on one or more qualified student loans must send Form 1098-E to each borrower by January 31, 2022.
Conclusion
In short, one can avail of a student loan deduction if you satisfy the following conditions mentioned above. You must also follow the process as given in the act. For checking your eligibility, you can check the official website of the IRS-Interactive Tax Assistant.
Frequently Asked Questions
What is pub.970 as referred to in the worksheet 4-1?
Ans: There are 11 chapters under publication 970. They are guidelines provided by the IRS for the purpose of return filling. For more details, click here.
When should you pay the loan interest?
Ans: Until your loan is paid off, the amount of interest you will keep paying every year, is allowed to be deducted.
What is the definition of modified adjusted gross income (MAGI)?
Ans: There are different definitions of MAGI as per different forms applicable to the taxpayer. If you file Form 1040-NR, MAGI is the AGI, i.e., adjusted gross income, on line 11 of that form figured without taking into account any amount on Schedule 1 (Form 1040), line 21.
Which are the forms that I need to fill out before availing of this deduction?
Ans: You must complete the filling of Form 1040 or 1040-SR (SR means senior citizen), as applicable, and Schedule 1, lines 11 through 20, 23, and 25. Then you can only avail a deduction on the student loan interest.
Which educational institutions are called eligible educational institutions?
Ans: An eligible educational institution is generally any accredited public, non-profit, or proprietary (privately owned, profit-making) college, university, vocational school, or other postsecondary educational institution.
The institution must be eligible to participate in a student aid program administered by the U.S. Department of Education.
When are qualified education expenses considered to have been paid or incurred?
Ans: The following requirements are to be met:
They are related to specific academic periods.
The loan proceeds need to be disbursed within a period that begins 90 days before the start of that academic period and ends 90 days after the end of that academic period.
If it is greater, the actual amount charged can be taken into consideration, if the student is residing in housing owned or operated by the eligible educational institution.
Comments