If you have outstanding student loans, you may benefit greatly by deducting the interest that is paid on them. Interest payments on student loans are deductible as an above the line deduction. This means that a taxpayer can deduct the interest whether or not they itemize deductions.
In 2012, a person who is eligible for the student loan interest deduction may deduct up to $2,500 of interest expense on a qualified education loan. If you are unsure if your loan qualifies for the deduction, please refer to Code Sec. 221 for more clarification.
Deduction Phase Out
The deduction is phased out for single taxpayers with adjusted gross income between $60,000 and $75,000 and for joint return filers with adjusted gross income between $120,000 and $150,000.
In the event that a taxpayer files a married filing separately tax return; they are unable to take the student loan interest deduction.
Also, an individual is not entitled to the deduction if the taxpayer can be claimed as a dependent by another taxpayer for the tax year beginning in the calendar year in which the individual’s tax year begins. Remember that the key word here is “can”; the taxpayer does not have to be claimed as a dependent to be unable to take the deduction.
To understand this concept better, here is a real life example:
In 2012, Mike paid $1,800 interest on a qualified education loan. His modified AGI was $66,000. Mike is single, which means his deduction for qualified student loan interest is phased out by the ratio of his excess AGI ($6,000), which is then divided by $15,000.
In this case, his deduction for student loan interest is reduced by 40% ($6,000/$15,000). Remember that the phase out rules for student loan interest apply to the deduction itself, rather than to the limitation on that deduction. To reduce this deduction properly multiply $1,800 times 60% in order to get $1,080.