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COLLEGE SAVINGS 101

Can I claim a deduction on college loan?

07/02/2007

QUESTION:
Dear Joe,

If I took out an Xpress Loan to finance my daughter's college, would the interest possibly be tax deductible? Yes, I itemize my deductions.
Thanks in advance.

-- Tom

ANSWER:
Dear Tom,

The tax law allows a deduction of as much as $2,500 per year for interest paid on a loan taken out and used exclusively to pay college costs. The loan won't count if it came from a relative, from a related entity such as family-owned corporation, or from a 401(k) plan. And, since the deduction is claimed "above the line," it doesn't require that the taxpayer itemize on their tax return. However, a number of other requirements must be met in order to take advantage of this tax break.

The first thing I wonder about is who is legally obligated to pay the interest on the loan: you or your daughter? If her name is on the loan, she gets to claim the deduction on her tax return. She must meet the income limits described below and not have anyone else, such as you, claiming an exemption for her on their return. Even if you decide to make the loan payments for her, it's her deduction, not yours.

If the loan is in your name, and your daughter did not provide more than one-half her own support in the year you took out the loan (i.e. she was your dependent), then you become eligible to claim the deduction for the interest paid on the loan.

Assuming it's your loan, and that you are paying more than $2,500 in interest for the year, you'll get the full $2,500 deduction only if your modified adjusted gross income is below $50,000 (single) or $105,000 (married filing jointly). You'll receive a partial deduction if your income is between $50,000 and $65,000 (single) or $105,000 and $135,000 (joint).

These are the income limits for 2006, and they increase every year for inflation. You cannot claim the deduction if you are married filing separately.

It takes the IRS six full pages, including a 16-line work sheet, to describe the deduction for student loan interest in Publication 970, Tax Benefits for Education. You'll need to wade through all that material to be sure you can claim this particular tax break.

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