Scott Reddersen

Millions of students returning to college campuses this month received a back-to-school gift from Congress with an interest rate reduction for federal student aid. After rates on new Direct Subsidized Loans had doubled from 3.40% to 6.80% as of July 1st, the Senate and House approved a new system which ties current and future rates to the 10-Year Treasury note. In the short-term, that effectively lowers rates from 6.80% to 3.86% for undergraduate students and from 6.80% to 5.41% for graduate students.

This comes at an appropriate time, with the Department of Education releasing a report showing that 57% of undergraduates in 2011-2012 used federal student aid to offset the ever-increasing costs to attend college. Just four years earlier, only 47% of undergraduates tapped federal financial aid.

Deducting Interest Paid on Educational Loans

While we won’t debate the pros and cons of the new rate system, now is a good reminder of what interest paid on educational loans is deductible:

Currently, a maximum deduction of $2,500 is allowed for interest paid by a taxpayer on any qualified education loan. Generally, a qualified education loan is any debt incurred to pay tuition, room, board, and other expenses related to attendance at a post-high school educational institution. The deduction is an above-the line deduction, meaning it directly offsets a taxpayer’s adjusted gross income.

The deduction is only available for the taxpayer who is legally obligated to make the payments, and is not allowed for a taxpayer who can be claimed as a dependent on another tax return. The deduction phases out for single filers with adjusted gross income exceeding $60,000 and is completely phased out at $75,000. For married taxpayers, the deduction begins phasing out at $125,000 and is completely phased out at $155,000. There is no deduction allowed for married taxpayers filing separate returns.

Assuming debt to meet soaring educational costs is becoming a reality for more and more taxpayers. While the current decrease in rates paired with an available deduction for many taxpayers does little to offset those increased costs, they are undoubtedly a welcomed boost.