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Student loan interest and who gets the deduction

Posted: March 14, 2012 - 12:20am

Are you a student or a parent of one who has taken out student loans? The interest on a student loan repaid is considered to be an adjustment to income and can reduce your earnings whether you itemize your other deductions or not. This deduction can be taken on loans issued to yourself, spouse, or your dependents. The loan must be for qualified educational expenses and cannot come from a related party.

If you are the person who took out the loan and are legally obligated to pay it, the fact that someone else actually pays it doesn’t matter as you are entitled to take the deduction. The theory behind this conclusion is that you are considered as having received the money from the other person and then making the payments yourself. The amount of deduction is limited to a cap of $2,500 and the student must be enrolled for at least half time in a program that will lead to a degree, certification or other credential. As in many other deductions there is a phase-out based on your income.

The student loan interest deduction is intended to cover tuition, fees, room and board, books and supplies and other necessary expenses. The cost of transportation may also be part of this group. In the event you refinance the original student loan for an amount in excess of that loan and use the funds for other than the qualified educational expenses, none of the interest charges would be deductible. The lending agency will issue a Form 1098-I at the end of the year to the payee and the IRS for verification.

Tuition and fees deduction

In addition to the student loan interest, you can also take a deduction for college tuition and fees expenses on the front page of the Form 1040. If you have an eligible dependent who can be claimed as an exemption and you paid the educational expenses, than only you can deduct them. The dependent cannot take the deduction. The maximum amount that can be claimed is $4,000 and is determined by the income level of the taxpayer. It is not necessary to claim itemized deductions to deduct these costs. The allowable expenses are limited to the tuition and fees that are necessary for enrollment. Books, supplies, room and board and other costs are not included as allowable expenses. The taking of at least one class during the academic year will allow this deduction to be reported. The deduction is not allowed to married couples that are filing separate returns.

Instead of taking the tuition and fees deduction, it might be more advantageous to use these expenses and take it as a credit on page two of the Form 1040. This credit has a different income maximum and should be carefully considered before claiming it. The difference between a credit and a deduction is this: Deductions reduce income that will be taxed but credits are a direct reduction dollar for dollar from the amount due. As you can see credits are generally better than deductions. But like everything else, there are two different types of credits with differences. They are the American Opportunity Credit (AOC) and the Lifetime Learning Credit (LLC). The AOC has a maximum of $2,500 per eligible student where in the LLC has a credit of $2,000 per return. The AOC is only available for four years per eligible student and the LLC is unlimited in its duration.

To be continued: Includes discussion regarding worthlessness of student loans.

Observation: Be careful, the handwriting on the wall may be a forgery.


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