The advent of a new year is the time to start preparing to file income taxes. This year, that process for many student loan borrowers includes understanding the implications of the coronavirus pandemic on possibly getting a student loan interest deduction for 2020.
While the March 2020 CARES Act temporarily paused payments, froze interest rates at 0% and halted debt collection for most federal student loans ultimately through Jan. 31, 2021– thanks to extensions of the forbearance period — student loan borrowers in repayment were required to make payments for a few months in early 2020.
By October, less than 11% of people with federal student loans had chosen to continue making payments during the automatic forbearance period, according to an analysis of data by Mark Kantrowitz, a financial aid expert.
Although President-elect Joe Biden’s transition team announced last week that his administration will extend the CARES Act student loan relief after he takes office Jan. 20, this is still a good time for borrowers to understand the student loan interest deduction whether they made payments only during the pre-CARES Act months of 2020 or continued to pay down their debt for the entire year.
Review the Student Loan Interest Statement
To learn how much paid student loan interest you may be able to deduct on your federal income tax return, start with the Student Loan Interest Statement, the Internal Revenue Service form used to help eligible borrowers claim a partial or full deduction. The statement, also known as Form 1098-E, is a tax form that all student loan servicers and lenders are required to send to borrowers who paid $600 or more of interest on a student loan during the tax year.
As illustrated on this example of a 1098-E on the IRS website, the form provides space for the servicer or lender to list all the interest included in student loan payments during the full tax year. Borrowers use this information to include the allowable interest deduction amount on the main federal tax form, the 1040, or on the new simplified federal tax form option for senior citizens, the 1040-SR.
For borrowers with qualified student loans held by more than one lender or servicer, a 1098-E will be issued by each. To qualify for a possible interest deduction, a student loan must have been used for qualified higher education expenses such as tuition, and the loan must be in the name of the tax filer or a spouse or qualified dependent.
If you paid at least $600 in student loan interest in 2020, be on the lookout for the form to arrive in the coming weeks. Federal law mandates that 1098-E forms be delivered to borrowers or postmarked no later than Jan. 31. Also note that student loan servicer websites typically provide online access to 1098-E forms, which borrowers can view by logging into their accounts.
Know Income Eligibility for Student Loan Interest Deduction
Just because a borrower receives a 1098-E form does not mean that he or she automatically qualifies for the student loan interest deduction. The IRS uses modified adjusted gross income, also known as MAGI, to determine whether filers qualify to take a student loan interest deduction.
For 2020 taxes, which are to be filed in 2021, the maximum student loan interest deduction is $2,500 for a single filer, head of household, or qualifying widow or widower with a modified adjusted gross income of less than $70,000.
For these filers, once their MAGI hits $70,000, the interest deduction begins to phase out. This means that the maximum allowable deduction at that point will be less than the full $2,500 and gradually decreases up to a modified adjusted gross income of $85,000, after which the interest deduction can’t be claimed.
Taxpayers who are married and filing jointly can deduct up to the maximum when their modified adjusted gross income is less than $140,000. The deduction begins to phase out at that amount and is eliminated completely once joint income reaches $170,000.
Married couples filing jointly should note that the student loan interest deduction applies per tax return. That means the maximum deduction allowed is $2,500 on a joint return, even if each spouse could have qualified for a $2,500 deduction by filing separately. Taxpayers married but filing separately don’t qualify for a student loan interest deduction.
Keep in mind that the student loan interest deduction may be available whether a borrower itemizes deductions or not, and can help lower the amount of income tax someone is required to pay by reducing adjusted gross income. This could result in a tax refund.
Depending on who took advantage of the temporary pause in payments, the 2020 CARES Act relief will affect the tax situation of some borrowers more than others.
For example, borrowers who continued to make student loan payments last year during the pause, or perhaps even made additional payments, will enjoy a greater reduction in 2020 taxable income than if they had made no payments during the forbearance period.
Borrowers can use student loan interest deduction calculators available online to check how they may benefit. For example, if you’re a taxpayer filing as single with a modified adjusted gross income of $50,000 last year and who paid $250 in student loan interest, you could subtract that amount from your total income when doing your taxes, resulting in a refund of $63.
Meanwhile, a married borrower filing jointly with a modified adjusted gross income of $60,000, plus the spouse’s adjusted income of $30,000 and $2,600 in student loan interest payments last year, could deduct the maximum of $2,500 on his or her taxes for a total of $625 toward a tax refund.
It’s important to know about the student loan interest deduction, especially when preparing to file taxes this year. Given extended CARES Act relief programs, now’s the time to understand how student loan payments can affect your income taxes.
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