Education Loan Interest is Not Always Tax Deductible

It seems to be a common statement among parents, planners, financial aid people, some bloggers, etc. that

Don’t worry about education loans, they are tax deductible…

Like most tax advice given…it is a half truth.

Student Loans Are not Always Tax Deductible

Yes, your interest is tax deductible if you don’t pass certain threshold income limits. As you will see, these threshold limits are not very high! As indicated by IRS Publication 970 Chapter 4 (2007),

The amount of your student loan interest deduction for 2007 is gradually reduced (phased out) if your modified adjusted gross income (MAGI) is between $55,000 and $70,000 ($110,000 and $140,000 if you file a joint return). You cannot take a deduction if your MAGI is $70,000 or more ($140,000 or more if you file a joint return).

What does this mean in English? In general terms we are going to just call what you make Gross Income; we aren’t going to worry about standard deductions, itemized deductions, modified adjusted gross income, etc.

• You make less than $55,000 – your student loan interest is fully tax deductible;
• You make more than $55,000 but less than $70,000 your deduction will be phased out depending on high that income goes; or
• You make more than $70,000 – your student loans are no longer tax deductible.

It should be noted that these are 2007 numbers – 2008 schedule has not been released yet; it is likely that this number will increase for 2008, but how high? From 2006 to 2007 it went from $65K – $70K. I won’t even try to conjure a guess as to where they will go next year, maybe another $5K increase? Keep it the same? I guess it will matter how much debt America continues to incur and who our next president is.

So I have shared some public information with you, now what?

1. Keep this in mind when someone tries to tell you to take out a bigger loan at a higher APR, because “Don’t worry the interest is tax deductible!”
2. More importantly, and the reason I created this post, the information provided herein should be taken into account when creating your debt repayment schedule.

I am lucky to only have student loans capped under 5%, but I have friends from law school with double digit interest rates, while having CC debt underneath it, but making 6 digits…well guess what the debt avalanche says to do?