As we approach tax season, student loan repayment becomes top of mind, especially finding the best options to deduct student interest. The question is how much student loan interest is deductible? Another analysis not often examined is whether I should give up the deduction?
Since 2016, more student loan borrowers are using the Income-Driven Repayment (IDR) methods such as Income Based Repayment (IBR), Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE). With this change, the traditional loan repayment strategies also changed. By using the IDR method, the taxpayer needs to do some additional tax planning if you are using or considering an IDR method. The IDR methods use a borrower’s Adjusted Gross Income (AGI) to determine the amount they will be paying which directly related to their income and taxes.
This is especially true for married couples since they could have up to 126 different student loan repayment and tax filing options if they both have federal loans. If you were married last year or if one of the spouses needs to start repaying their student loan, a proper tax analysis is highly recommended. We suggest a full review of your loan repayment options.
Student Loan Interest Deduction Phases Out
There is a phase-out of this deduction based on how a person or couple file their taxes and their income. The student loan interest deduction was originally on the cutting block under the initial tax reform act that started in 2018. The deduction was maintained which will be a big help for many citizens.
A borrower’s tax filing status will determine when that phase-out begins. This deduction uses a person Modified Adjust Gross Income (MAGI) to determine if you qualify. It also adds back a few additional tax exclusions that most borrowers will not have as listed below:
- Foreign Earned Income Exclusion
- Foreign Housing Exclusion
- Foreign Housing Deduction
- Income Exclusion for residents of American Samoa and Puerto Rico
The table below is the income limits to qualify for the student loan interest deduction based on a person’s or couples’ MAGI for the 2018 taxes.
If a couple or one of the spouses is using an IDR repayment method, you will need to take an additional step that most people do not do. You need to compare your AGI number and the impact it may have on your student loan repayment. The tax advisor’s job is to lower your taxes, but in most cases, they do not know the impact it will have on a borrower’s student loan repayment. Properly managing the borrower’s AGI could result in hundreds of dollars a month is a lower payment.
Let’s review this by tax filing options and student loan repayment impact. The tax filing and repayment options are only available if a borrower has federal student loans.
Single, Head of House Hold and Qualified Widow
In each of these cases, the tax filing status will have no impact on the student loan repayment. The Qualified Widow is the exception only if the surviving spouse has the outstanding student debt. In that case, they may want to contact their loan servicer or weigh their other tax filing options to manage their AGI better.
Married Filing Joint
A couple filing married and joint will still qualify for the student loan interest deduction. The problem they may face is with their IDR repayment. If both have federal loans, the income for the IDR repayment will be based on the percent of total federal loans by each borrower times the joint AGI.
If only one borrower is using an IDR method, this will make the payment much higher. Evaluating the filing married and separate should be reviewed to see if the increase in tax will offset the monthly repayment amount.
Filing Married but Separate
By filing married but separate, the couple will generally be paying a higher tax than filing married and joint for a variety of reasons. Regarding the student loan interest deduction, this will disqualify either of the filers to the deduction.
There could be a significant advantage to filing your taxes this way when it comes to loan repayment. If one of the spouses in using an IDR method, then only their AGI number will be used to calculate their loan repayment method. Here is where the borrower needs to be more aware of their situations and options.
In most cases, the tax advisor will not ask you the additional question or see the impact of filing your taxes this way. The PayForED Repayer provides the borrower with this additional analysis so the proper interpretation and decision can be made.
For people married in the prior year and will be filing their taxes for the first time as a couple, a full review should be done by a tax professional. This is especially true if either of the spouses has federal loan repayment under the IDR methods.
A big mistake many couples make is not correctly analyzing their options. There is a significant drop off in people qualifying for Public Service Loan Forgiveness after year 3 and 4. It is my opinion this occurs for a few reasons. One is their income goes up faster, and they do not qualify any longer. Another reason is the correlation in the age of the couple getting married and filing their taxes jointly. Filing their taxes jointly raises their incomes and repayment becomes higher.
Tax Advice Summary
As you can see, the student loan interest deduction is not as easy as it appears. The tax advisor goal is to lower a person’s or family’s taxes. Many tax advisors are unaware of the impact it may have a couple’s loan repayment and forgiveness options. You, as the borrower, need to take the extra steps for yourself to both lower your taxes and your loan repayments. The PayForED Student Loan Repayer calculates both the loan repayment options and the impact of the taxes under each scenario.