Student loan payments are partially tax deductible — if you qualify

Student debt is a drain for over 43 million Americans, and no one’s stoked about an extra monthly payment. The average student loan balance may be as high as $39,981 — but there’s a bright side to those payments. 

Student loan payments are tax deductible…partially. 

Each debt payment is part interest, part principal (your original borrowed amount) — only student loan interest payments are tax deductible. 

There are also other tax benefits to help reduce your tax liability, freeing up money for education. Whether you’re going back to school or still paying off your bachelor’s degree, here’s what you need to know about student loans and taxes. 

Do you qualify for interest deductions?

You can take an above-the-line deduction up to $2,500 a year from your gross taxable income if you qualify for student loan interest deductions based on your modified adjusted gross income (MAGI). 

Married, joint filers earning less than $155,000 and single filers earning less than $75,000 qualify for the full deduction. 

Filers with a MAGI between $75,000-$90,000 (single) or $155,000-$185,000 (joint) will have their deduction gradually reduced. Earners above those thresholds will not qualify for any deduction for student loan interest. . 

This tax deduction isn’t just for grads paying back their student loans. Anyone paying interest on a qualified student loan can take a tax deduction, including if:

• You’re an active student making interest payments while enrolled. 
• You took the loan out for a dependent and are making student loan interest payments. 
• Your wages are garnished or you’re otherwise legally required to pay the loan. 

Married couples filing separately, people exceeding the MAGI limit, and those claimed as another taxpayer’s dependent don’t qualify for deductions of student interest payments. 

You also can’t take a deduction if your employer paid for your education, your loan doesn’t qualify, or your school isn’t a qualified institution. 

No matter how you’re paying off your student loans, make sure you record your interest payments and get any deductions you qualify for. 

File a deduction form to save on taxes

Interest payments reduce your taxable income during the same tax year you make payments. Your interest payments will be reported on Form 1098-E, which you’ll receive in the mail during tax season from your student loan servicer if you paid more than $600 in interest.  

Even if you don’t receive a statement from your loan servicer, you should report any interest you paid to the IRS on your annual tax return. You’ll just have to contact your loan servicer to confirm the interest you’ve paid.

How to leverage tax benefits and free up college funds

Deductible interest payments aren’t the only way to reduce your taxes. The federal government offers several opportunities to cover higher education costs without increasing your tax bill. 

Take the full annual interest deduction allowed

Before we get into other tax-advantaged opportunities, let’s make the most of our deductible debt payments. 

You can deduct up to $2,500 a year in student loan interest, and maximizing this deductible is a great way to reduce your debt and taxable income.  

Not sure what portion of your payments is interest or need help maximizing your tax advantages? Work with a financial advisor to organize your debt and investments for the best payoff. 

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Offset education costs with tax credits

Education tax credits are another way to reduce your taxable income that are not based on how much you spend on education. 

Two federal tax credits are available to eligible students currently enrolled in higher education. 

• American Opportunity Tax Credit (AOTC): A $2,500 annual credit, per eligible student, for the first four years of degree-granting education. 
• Lifetime Learning Credit (LLC): A $2,000 annual tax credit, per tax return, for any level of higher education, including undergraduate, graduate, and professional courses at an eligible educational institution. 

Eligibility for both is similar and requires enrollment in a qualified institution. However, specific enrollment guidelines, like your course load and when you enroll, vary. 

These also have MAGI limits to qualify (2023 tax year):

Use tax-advantaged education accounts

If you’re planning ahead for your return to school or squirreling away for your kid’s future, check out tax-advantaged education savings accounts. 

Coverdell education savings accounts (Coverdell ESA) collect funds for education, including primary, secondary, and higher education. So you can cover anything from private school tuition to university credits. 

Eligibility rules include:

• The account beneficiary must be younger than 18 or have a qualified disability at the time of opening the account. 
• You have to open the account as a Coverdell ESA from the beginning. 
• The account document has to be in writing and meet certain criteria. 

You can contribute up to $2,000 a year to a Coverdell ESA. Contributions aren’t deductible, but distributions are tax-free. 

Qualified tuition programs (QTPs) are state-provided accounts commonly called 529 plans. These plans cover education-specific costs, including enrollment, materials, and room and board. You can also distribute $10,000 a year per beneficiary for elementary and secondary education. 

Eligibility can vary by state, but most don’t have any kind of income or residency requirements. Contributions also vary among specific programs.

QTP contributions are tax-deductible at the state level, and earnings are tax-free. Any distributions used for qualified higher education expenses aren’t taxable, though you might owe taxes if your distribution exceeds educational needs. 

Both accounts can help you reach the financial goal of covering college costs. 

Take a penalty-free IRA distribution 

IRAs, including Roth, SEP, SIMPLE, and SARSEP plans, all permit penalty-free early distributions for qualified higher education expenses. 

Typically, you’d have to pay taxes and a 10% early withdrawal penalty on any distributions before age 59½. 

Since education costs are an exception, you can bypass the 10% fee, but you’ll still owe income taxes on the withdrawal (unless it’s a Roth IRA).

This isn’t ideal for your retirement, and there aren’t really any tax breaks (beyond the 10% early withdrawal penalty exemption). But it’s an option if you’re in a pinch, and it can reduce your student loan debt, which pays off in the long run. 

The Playbook take: Stay smart about taxes to save on school

Thousands of us are saddled with student debt, but you can make the most of a less-than-thrilling expense. Student loan interest payments are tax deductible, so remember to file each year to reduce your taxable income by up to $2,500.

Ready to study finance and prepare for your financial future? Playbook can create a roadmap with personalized recommendations to grow wealth, reduce debt, and cut taxes.