Americans certainly aren't strangers to student loans. Collectively, we owe an estimated $1.4 trillion, and given the ever-rising cost of college, that number is only likely to climb. In fact, the average Class of 2016 graduate came away $37,172 in debt, up 6% from just the previous year.
Continue Reading Below
The problem with student loans is that they're among the most difficult type of debt to shake -- even filing for bankruptcy won't get rid of them. Thankfully, the IRS offers those with educational debt a reasonable tax break in the form of the student loan interest deduction. That deduction could be worth up to $2,500 if you qualify, but there are rules regarding eligibility you'll need to follow.
IMAGE SOURCE: GETTY IMAGES.
How the student loan interest deduction works
At a maximum, you can deduct $2,500 in student loan interest provided those loans were taken out to pay for qualified higher education expenses. These include tuition, fees, books, equipment, and room and board. To claim the deduction, your tax filing status can't be married filing separately, and you can't be listed as a dependent on somebody else's tax return.
Furthermore, the student loan interest deduction is only applicable to your own personal debt. If, for example, you're kind enough to pay your grandchild's loan, you won't get to take a deduction for the interest (though your grandchild may be eligible to do so).
Continue Reading Below
As is the case with the majority of tax breaks, there are income limits that dictate whether you'll be allowed to claim the student loan interest deduction. If you're a single tax filer with a modified adjusted gross income (MAGI) of $65,000 or less, you'll be able to take the deduction in full. If you earn more than $65,000 but less than $80,000, you'll qualify for a partial deduction. And if your MAGI is $80,000 or more, you won't get it at all.
Married couples filing jointly are subject to the same income-based restrictions, only with higher thresholds. If you're a joint filer with a MAGI of $130,000 or less, you can take the deduction in full. Couples earning more than $130,000 but less than $160,000 get a partial deduction, and those earning $160,000 or more are disqualified.
How will the deduction benefit you?
Tax deductions in general work by excluding a portion of your earnings from taxes, so your savings are based on your effective tax rate. Say your effective tax rate is 25% and you're eligible to deduct the full $2,500 in student loan interest. In that case, you'd shave $625 off your tax bill. The higher your effective tax rate, the more valuable each individual deduction becomes, so it pays to see whether you qualify to write off interest on your loans.
One final thing to note is that you don't actually need to itemize deductions on your tax return to write off your student loan interest. Because this particular deduction is taken above the line, it's considered an adjustment to income and doesn't require itemizing.
If you've been paying off student loans, it's worth seeing whether you qualify to take an interest deduction. Though you can write off any amount of interest up to the $2,500 limit, your lender is required to send you Form 1098-E if you pay $600 or more in interest over the course of a given year, which will make figuring your deduction even easier. If you don't have that form handy, you can always reach out to your lender or review your previous student loan statements for a breakdown. Though either step might involve a bit of legwork, it'll be worth the effort if it puts money back in your pocket during tax season.
The $16,122 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.