Student Loan Interest Deduction

If you paid interest on a student loan in 2001, you may be able to deduct up to $2,500 of the interest you paid. You can deduct interest paid during the first 60 months that interest payments are required on the loan.

If you pay $600 or more 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 return.

What is the tax benefit of the student loan interest deduction? The student loan interest deduction can reduce the amount of your income subject to tax by up to $2,500 in 2001.

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).

What Is Student Loan Interest?

Generally, student loan interest is interest you paid during the year on a loan you took out to pay qualified education expenses (defined later) that were:

1. For you, your spouse, or a person who was your dependent (defined later under Can You Claim the Deduction) when you took out the loan,
2. Paid within a reasonable period of time (defined later under Can You Claim the Deduction) before or after you took out the loan, and
3. For an eligible student (defined later under Can You Claim the Deduction).

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.

Do Not Include As Interest

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

• The interest was paid on a loan from a related person.
• The interest was paid on a loan from a qualified employer plan.

Loan from a related person. You cannot deduct interest on a loan you get from a related person. Related persons include:

• Your spouse,
• Your brothers and sisters,
• Your half brothers and half sisters,
• Your ancestors (parents, grandparents, etc.),
• Your lineal descendants (children, grandchildren, etc.), and
• 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.

Can You Claim the Deduction?

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

1. Your filing status is any filing status except married filing separately.
2. No one else is claiming an exemption for you on his or her tax return.
3. 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.
4. The education expenses were paid or incurred within a reasonable period of time before or after the loan was taken out.
5. The person for whom the expenses were paid or incurred was an eligible student.
6. The first 60 months in which interest payments were required on the loan did not end before January 2001.

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

Is Someone Else Claiming Your 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).

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 a Coverdell ESA (formerly known as 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.
• Veterans' educational assistance benefits.
• Any other nontaxable payments (other than gifts, bequests, or inheritances) received for education 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).

Who Is a 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, Exemptions, Standard Deduction, and Filing Information.

What Is a Reasonable Period of Time?

Qualified education expenses are treated as paid or incurred within a reasonable period of time before or after the debt is incurred if they are paid with the proceeds of education loans that are part of a federal post-secondary education loan program.

Even if they are not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of the following requirements are met.

1. The expenses relate to a particular academic period, and
2. 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.

If neither of the above situations applies, the reasonable period of time usually is determined based on all the relevant facts and circumstances.

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 those established by the Department of Education under the Higher Education Act of 1965.

Student Loan Interest Deduction at a Glance

What Is the 60-Month Period?

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

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

Example. You took out a student loan in 1994. You made a payment on the loan every month, as required, beginning October 1, 1996. You can deduct the interest on your first nine payments for 2001. You cannot deduct the interest on any later payments because they are after the 60-month period (October 1, 1996 - September 30, 2001).

Beginning in 2002, the requirement that you can only deduct interest paid during the first 60 months that interest payments are required is eliminated. See Publication 553 for more information.

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 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, later.

Example. You obtained a qualified education loan to pay for an undergraduate degree at an eligible educational institution. After graduation, you were required to make monthly interest payments on the loan beginning in January 2000. You made the required interest payments through March 2001 (15 months).

In April 2001, you borrowed money from a different lender for no other reason than to pay off the first education loan. This new loan required you to start making interest payments immediately. Since this is a single loan used to pay off the original single loan, you have only forty-five months remaining of the original 60-month student loan interest deduction period.

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.

Example. You obtained a qualified education loan to pay for an undergraduate degree at an eligible educational institution. After graduation, you were required to make monthly interest payments on the loan beginning in January 2000. You made the required interest payments through March 2001 (15 months).

You had also obtained a second qualified education loan to pay for a graduate degree at an eligible educational institution. After graduation, you were required to make monthly interest payments on the second loan beginning in January 2001. You made the required interest payments through March 2001 (3 months).

In April 2001, you borrowed money from a lender for no other reason than to combine both education loans into one loan payment. This new loan required you to start making interest payments immediately. You have fifty-seven months remaining of the original 60-month period because only three months had passed since the most recent date on which interest payments became due on either of the two loans (January 2001).

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.

Example. To finance your education, you obtained four separate qualified education loans. The loans entered repayment status on the following dates.

• January 1, 2000.
• April 1, 2000.
• July 1, 2000.
• October 1, 2000.

In January 2001, your lender advised you that all four had been transferred to a different lender for loan servicing purposes.

The new lender treats the loans as a single loan and does not keep separate records for each loan. You are sent a single statement that shows the total principal and interest.

Your 60-month period for deducting interest on the collapsed loan is considered to have started on October 1, 2000, the most recent date that any of the four original loans entered repayment status.

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) during a period of deferment or forbearance.
2. You elect to make interest payments during this period, rather than have the interest capitalized.

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.

How Much Can You Deduct?

Your student loan interest deduction for 2001 is generally the smaller of:

1. $2,500, or
2. Your interest payments that were both:
1. Paid in 2001, and
2. Paid during the first 60 months that interest payments were required.

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

Does the Amount of Your 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.

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 2001 you paid $800 interest on a qualified student loan. Your 2001 modified adjusted gross income is $72,000 and you are filing a joint return. You must reduce your deduction by $640, figured as follows.

You can deduct $160 ($800 - $640).

Example 2. The facts are the same as in Example 1 except that you paid $2,750 interest. Your maximum deduction for 2001 is $2,500. You must reduce your maximum deduction by $2,000, figured as follows.

You can deduct $500 ($2,500 - $2,000).

Modified adjusted gross income. For most taxpayers, modified adjusted gross income (MAGI) is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for student loan interest.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 19 of that form figured without taking into account any amount on line 17 (Student loan interest deduction).

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 33 of that form figured without taking into account any amount on line 24 (Student loan interest deduction), and modified by adding back any:

1. Foreign earned income exclusion,
2. Foreign housing exclusion or deduction,
3. Exclusion of income for bona fide residents of American Samoa, and
4. Exclusion of income from Puerto Rico.

How Is the Deduction Figured?

Generally, you figure the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040 or Form 1040A instructions. However, if you are filing Form 2555, 2555-EZ, or 4563, or you are excluding income from sources within Puerto Rico, you must complete Worksheet 3-1 in this publication.

Worksheet 3-1. Student Loan Interest Deduction Worksheet

How Is the Deduction Claimed?

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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