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Publication 970 2003 Tax Year

Student Loan Interest Deduction

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Table of Contents

Introduction

Generally, personal interest you pay, other than certain mortgage interest, is not deductible on your tax return. However, there is a special deduction allowed for paying interest on a student loan (also known as an education loan). This deduction can reduce the amount of your income subject to tax by up to $2,500 in 2003.

The student loan interest deduction is taken as an adjustment to income. This means you can claim this deduction even if you do not itemize deductions on Schedule A (Form 1040).

This chapter explains:

  • What type of loan interest you can deduct,
  • Whether you can claim the deduction,
  • What expenses you must have paid with the student loan,
  • Who is an eligible student,
  • Who can claim a dependent's expenses,
  • How to figure the deduction, and
  • How to claim the deduction.

Table 4–1 summarizes the features of the student loan interest deduction.

Table 4–1. Student Loan Interest Deduction at a Glance

Do not rely on this table alone. Refer to the text for complete details.
Feature Description
Maximum benefit You can reduce your income subject to tax by up to $2,500.
Loan qualifications Your student loan:
•
must have been taken out solely to pay qualified education expenses, and
  • cannot be from a related person or made under a qualified employer plan.
Student qualifications The student must be:
• you, your spouse, or your dependent, and
  • enrolled at least half-time in a degree program.
Time limit on deduction You can deduct interest paid during the remaining period of your student loan.
Phaseout The amount of your deduction depends on your income level.

Student Loan Interest Defined

Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntary interest payments.

Qualified Student Loan

This is a loan you took out solely to pay qualified education expenses (defined later) that were:

  1. For you, your spouse, or a person who was your dependent when you took out the loan,
  2. Paid or incurred within a reasonable period of time before or after you took out the loan, and
  3. For education provided during an academic period for an eligible student.

Loans from the following sources are not qualified student loans.

  • A related person.
  • A qualified employer plan.

Your dependent.

Generally, your dependent is someone who:

  • Receives most of his or her support from you,
  • Is either related to you or lives with you, and
  • Is a citizen or resident of the United States, Canada, or Mexico.

You can find more information about dependents in Publication 501, Exemptions, Standard Deduction, and Filing Information.

Reasonable period of time.

Qualified education expenses are treated as paid or incurred within a reasonable period of time before or after you take out the loan if they are paid with the proceeds of student loans that are part of a federal postsecondary education loan program.

Even if not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of the following requirements are met.

  1. The expenses relate to a specific academic period, and
  2. The loan proceeds are disbursed within a period that begins 60 days before the start of that academic period and ends 60 days after the end of that academic period.

If neither of the above situations applies, the reasonable period of time usually is determined based on all the relevant facts and circumstances.

Academic period.

An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period.

Eligible student.

This is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.

Enrolled at least half-time.

A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.

The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than any of those established by the Department of Education under the Higher Education Act of 1965.

Related person.

You cannot deduct interest on a loan you get from a related person. Related persons include:

  • Your spouse,
  • Your brothers and sisters,
  • Your half brothers and half sisters,
  • Your ancestors (parents, grandparents, etc.),
  • Your lineal descendants (children, grandchildren, etc.), and
  • Certain corporations, partnerships, trusts, and exempt organizations.

Qualified employer plan.

You cannot deduct interest on a loan made under a qualified employer plan or under a contract purchased under such a plan.

Qualified Education Expenses

For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items.

  1. Tuition and fees.
  2. Room and board.
  3. Books, supplies, and equipment.
  4. Other necessary expenses (such as transportation).

The cost of room and board qualifies only to the extent that it is not more than the greater of the following two amounts.

  1. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
  2. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Eligible educational institution.

An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.

For purposes of the student loan interest deduction, the term also includes an institution conducting an internship or residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers postgraduate training.

Tip

The educational institution should be able to tell you if it is an eligible educational institution.

Adjustments to Qualified Education Expenses

You must reduce your qualified education expenses by the total amount paid for them with the following tax-free items.

  • Employer-provided educational assistance. See chapter 11.
  • Tax-free distributions from a Coverdell education savings account (ESA). See chapter 7.
  • Tax-free distributions from a qualified tuition program (QTP). See chapter 8.
  • U.S. savings bond interest that you exclude from income because it is used to pay qualified education expenses. See chapter 10.
  • The tax-free part of scholarships and fellowships. See chapter 1.
  • Veterans' educational assistance. See chapter 1.
  • Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.

Include As Interest

In addition to simple interest on the loan, if all other requirements are met, the items discussed below can be student loan interest.

Loan origination fees.

These are the costs (other than fees for services) of getting the loan.

Capitalized interest.

This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan.

Interest on revolving lines of credit.

This interest, which includes interest on credit card debt, is student loan interest if the borrower uses the line of credit (credit card) only to pay qualified education expenses. See Qualified Education Expenses, earlier.

Interest on refinanced student loans.

This includes interest on both:

  • Consolidated loans — loans used to refinance more than one student loan of the same borrower, and
  • Collapsed loans — two or more loans of the same borrower that are treated by both the lender and the borrower as one loan.

Voluntary interest payments.

These are payments made on a qualified student loan during a period when interest payments are not required, such as when the borrower has been granted a deferment.

Example.

The payments on Roger's student loan were scheduled to begin in June 2002, 6 months after he graduated from college. He began making payments as required. In September 2003, Roger enrolled in graduate school on a full-time basis. He applied for and was granted deferment of his loan payments while in graduate school. Wanting to pay down his student loan as much as possible, he made loan payments in October and November, 2003. Even though these were voluntary (not required) payments, Roger can deduct the interest paid in October and November.

When Must Interest Be Paid

Beginning in 2002, you can deduct all interest you paid during the year on your student loan, including voluntary payments, until the loan is paid off. Prior to that, you could deduct only the interest paid during the first 60 months you were required to make interest payments on the loan.

If you started making required payments before 2002, and your payments continued into 2002 or later, see Table 4–2 and the example that follows. These illustrate how your student loan interest deduction may have changed.

Table 4–2. Changes in Allowable Deduction Period for Student Loan Interest
Year You Made Interest Payments Interest Deduction Allowed
Before 1998 No deduction allowed.
1998 – 2001 Interest paid during the first 60 months that interest payments are required on the student loan.
2002 and later All interest paid on student loan during year, both required and voluntary payments.

Example.

You took out a qualified student loan in 1994. Beginning October 1, 1996, you made a payment on the loan every month, as required. In September 2002, you received a small inheritance that allowed you to make an extra payment on your loan during October, November, December, and January. You made your final loan payment in August 2003. No student loan interest deduction was allowed before 1998. The following interest payments would qualify for deduction.

  1996:   None
  1997:   None
       
  1998:   12 payments (1st year deduction allowed)
  1999:   12 payments
  2000:   12 payments
  2001:   9 payments (60-month period ended in
September)
       
  2002:   15 payments (law changed — 12 required
+ 3 voluntary payments)
  2003:   9 payments (8 required + 1 voluntary)

Do Not Include As Interest

You cannot claim a student loan interest deduction for interest on a loan if, under the terms of the loan, you are not legally obligated to make interest payments.

Can You Claim the Deduction

Generally, you can claim the deduction if all three of the following requirements are met.

  1. Your filing status is any filing status except married filing separately.
  2. No one else is claiming an exemption for you on his or her tax return.
  3. You paid interest on a qualified student loan.

Claiming an exemption for you.

Another taxpayer is claiming an exemption for you if he or she lists your name and other required information on line 6c of his or her Form 1040 (or Form 1040A).

Example.

During 2003, Josh paid $600 interest on his qualified student loan. Only he is legally obligated to make the payments. No one claims an exemption for Josh for 2003. Assuming all other requirements are met, Josh can deduct the $600 of interest he paid on his 2003 Form 1040 or 1040A.

No Double Benefit Allowed

You cannot deduct as interest on a student loan any amount that is an allowable deduction under any other provision of the tax law (for example, as home mortgage interest).

Who Can Claim a Dependent's Expenses

You can deduct interest paid on a student loan for your dependent only if you:

  1. Are legally obligated to make the interest payments,
  2. Actually made the payments during the tax year, and
  3. Claim an exemption for your dependent on your tax return.

You are not considered to have made student loan interest payments actually made by your dependent, regardless of whether your dependent is legally liable for the loan. Also, payments made by anyone other than your dependent are not considered made by your dependent.

Example.

During 2003, Jo paid $1,100 interest on her qualified student loan. Only she is legally obligated to make the payments. Jo's parents claimed an exemption for her on their 2003 tax return. In this case, neither Jo nor her parents may deduct the student loan interest Jo paid in 2003.

Figuring the Deduction

Your student loan interest deduction for 2003 is generally the smaller of:

  1. $2,500, or
  2. The interest you paid in 2003.

However, the amount determined above may be gradually reduced (phased out) or eliminated based on your filing status and modified adjusted gross income (MAGI) as explained below. You can use Worksheet 4–1 (see next page) to figure both your MAGI and your deduction.

Form 1098–E.

To help you figure your student loan interest deduction, you should receive Form 1098–E, Student Loan Interest Statement. Generally, an institution (such as a bank or governmental agency) that received interest payments of $600 or more during 2003 on one or more qualified student loans must send Form 1098–E (or acceptable substitute) to each borrower by February 2, 2004.

The lender may ask for a completed Form W–9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification, or similar statement to obtain the borrower's name, address, and taxpayer identification number. The form may also be used by the borrower to certify that the student loan was incurred solely to pay for qualified education expenses.

Effect of the Amount of Your Income on the Amount of Your Deduction

The amount of your student loan interest deduction is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $50,000 and $65,000 ($100,000 and $130,000 if you file a joint return). You cannot take a student loan interest deduction if your MAGI is $65,000 or more ($130,000 or more if you file a joint return).


Modified adjusted gross income (MAGI).

For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for student loan interest.

MAGI when using Form 1040A.

If you file Form 1040A, your MAGI is the AGI on line 22 of that form figured without taking into account any amount on line 18 (Student loan interest deduction) or line 19 (Tuition and fees deduction).

MAGI when using Form 1040.

If you file Form 1040, your MAGI is the AGI on line 35 of that form figured without taking into account any amount on line 25 (Student loan interest deduction) or line 26 (Tuition and fees deduction), and modified by adding back any:

  1. Foreign earned income exclusion,
  2. Foreign housing exclusion,
  3. Foreign housing deduction,
  4. Exclusion of income for bona fide residents of American Samoa, and
  5. Exclusion of income from Puerto Rico.

Table 4–3 shows how the amount of your MAGI can affect your student loan interest deduction.

Table 4–3. Effect of MAGI on Student Loan Interest Deduction
IF your filing status is... AND your MAGI is... THEN your student loan interest deduction is...
single,

head of household,
or 		not more than $50,000 not affected by the phaseout.
more than $50,000
but less than $65,000 		reduced because of the phaseout.
qualifying widow(er) $65,000 or more eliminated by the phaseout.
married filing joint return not more than $100,000 not affected by the phaseout.
more than $100,000
but less than $130,000 		reduced because of the phaseout.
  $130,000 or more eliminated by the phaseout.

Phaseout.

If your MAGI is within the range of incomes where the credit must be reduced, you must figure your reduced deduction. To figure the phaseout, multiply your interest deduction (before the phaseout) by a fraction. The numerator is your MAGI minus $50,000 ($100,000 in the case of a joint return). The denominator is $15,000 ($30,000 in the case of a joint return). Subtract the result from your deduction (before the phaseout). This result is the amount you can deduct.

Example 1.

During 2003 you paid $800 interest on a qualified student loan. Your 2003 MAGI is $125,000 and you are filing a joint return. You must reduce your deduction by $667, figured as follows.

  $800 × $125,000 - $100,000
$30,000 		= $667  

Your reduced student loan interest deduction is $133 ($800 - $667).

Example 2.

The facts are the same as in Example 1 except that you paid $2,750 interest. Your maximum deduction for 2003 is $2,500. You must reduce your maximum deduction by $2,083, figured as follows.

  $2,500 × $125,000 - $100,000
$30,000 		= $2,083  

In this example, your reduced student loan interest deduction is $417 ($2,500 - $2,083).

Which Worksheet To Use

Generally, you figure the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040 or Form 1040A instructions. However, if you are filing Form 2555, 2555–EZ, or 4563, or you are excluding income from sources within Puerto Rico, you must complete Worksheet 4–1 below.

Claiming the Deduction

The student loan interest deduction is an adjustment to income. To claim the deduction, enter the allowable amount on line 25 of Form 1040, or line 18 of Form 1040A.

Worksheet 4–1. Student Loan Interest Deduction Worksheet (Keep for Your Records)
  Use this worksheet instead of the worksheet in the Form 1040 instructions if you are filing Form 2555, 2555–EZ, or 4563, or you are excluding income from sources within Puerto Rico. You must complete Form 1040, lines 7 through 24 and lines 27 through 32a, plus any amount to be entered on the dotted line next to line 33, before using this worksheet.
1. Enter the total interest you paid in 2003 on qualified student loans. Do not enter
more than $2,500		 1.  
2. Enter your total income from Form 1040, line 22 2.      
3. Enter the total of amounts from Form 1040,
lines 23 and 24 		3.          
4. Enter the total of amounts from Form 1040,
lines 27 through 32a, plus any amount you
entered on the dotted line next to line 33 		4.          
5. Add the amounts on lines 3 and 4 5.      
6. Subtract the amount on line 5 from the amount on line 2 6.      
7. Enter any foreign earned income exclusion and/or housing
exclusion (Form 2555, line 43, or Form 2555–EZ, line 18) 		7.      
8. Enter any housing deduction (Form 2555, line 48) 8.      
9. Enter the amount of income from Puerto Rico that you are excluding 9.      
10. Enter the amount of income from American Samoa that
you are excluding (Form 4563, line 15) 		10.      
11. Add the amounts on lines 6 through 10. This is your modified adjusted gross income 11.  
12. Enter the amount shown below for your filing status 12.  
  •Single, head of household, or qualifying widow(er) — $50,000    
  •Married filing jointly — $100,000    
13. Is the amount on line 11 more than the amount on line 12?    
  □ No. Skip line 14, enter -0- on line 15, and go to line 16.    
  □ Yes. Subtract line 12 from line 11 13.  
14. Divide line 13 by $15,000 ($30,000 if married filing jointly). Enter the result as a decimal
(rounded to at least three places). If the result is 1.000 or more, enter 1.000 		14. .
15. Multiply line 1 by line 14 15.  
16. Student loan interest deduction. Subtract line 15 from line 1. Enter the result here
and on Form 1040, line 25. Do not include this amount in figuring any other
deduction on your return (such as on Schedule A, C, E, etc.) 		16.  

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