I.R.S. College Student Loan Interest Deduction Underestimates the True Costs of Education

by Broke Professional on March 9, 2011 · 18 comments

Thank you to a new BP reader, Jeff for suggesting the idea for this blog post on the student loan interest deduction tax law.  We are always excited to hear and interact with readers, just shoot us an email at webhost@brokeprofessionals.com or use the contact us form if you have any ideas, suggestions, etc.  Our site is growing (more than 5,000 visits per month now) but still small enough that we can respond to almost every email we receive (so long as it isn’t spam).  If you haven’t already, please subscribe to our site! (It don’t cost nothing).

College Student Loan Interest Deduction

People with a large amount of debt such as my wife and I are often asked what type of debt we have.  “Student Loan Debt, and that’s it” we always reply (although this will change soon now that we are in the middle of purchasing our first house).

“That’s good debt.” We always here back.

One of the main reasons people cite as to why it is good debt is the alleged big tax benefits.  Now I am not a tax expert, in fact tax law was probably my least favorite class in law school.  That said, my understanding of the current law is, not as an attorney but just some blogger doing a little internet research, as follows:

  • The current student loan interest deduction is relatively new. It was set to expire this year but was extended
  • It allows $2,500 to be deducted (or the amount of interest paid, whichever sum is smaller) (even when using a standard form).  Only the person responsible for repayment of the loan can deduct it and married parties filing separately cannot each take this deduction.  It appears that married couples can, like their single counterparts only deduct $2,500 total, even if they are in a situation like my wife and I, who are both repaying our own separate student loan debt that we accrued in large part or entirely prior to our marriage.
  • Now this is where it gets important for my rant (see below): there is a phase-out of the amount you may deduct once your salary reaches $60,000 if you are single, and $120,000 if filing joint.  You may not claim this interest at all if you earn more than $75,000 single or $150,000 joint.

(Note: If you want the full deal straight from the horses mouth, click on this link to see more details from the IRS website regarding the student loan interest deduction.)

Student Loan Interest Deduction: Rant (Opinion)

Now like most blogs a lot of what I write on the site can be classified as my opinion.  However, I usually try not to be opinionated.

I am making an exception here because I do not believe there should be an income cap on this $2,500 maximum deduction.

Now I know some of you may be thinking, why should those “rich” people that earn more than $75,000 single or $150,000 joint get any such benefit.  I probably use to think like that myself, but the fact of the matter is, if you are earning that much money then you likely had to take out a lot of student loans.  (Also, today $150,000 for a family does not make you rich if you have a high debt load, etc).

Although most interest cannot be written off and the student loan interest deduction is a special exception, this neglects the correlation between a higher salary and the amount of student loans needed in many cases to achieve that salary level.

In other words, people who will receive this deduction may have correspondingly smaller student loan balances,  whereas a person earning what may appear to be a large sum of money like $75,000 may be paying $10,000+ per year in interest, thus leveling the playing field.

That same student loan interest cannot be discharged in bankruptcy (except in the most extreme of examples).  Moreover, like almost all debt, if your student loan debt was somehow forgiven, it would be considered taxable income.

A final point is this: aren’t people in the higher bracket already penalized enough by paying higher taxes anyway?  Shouldn’t we be inspiring people to earn more, particularly if they have a lot of student loan debt owed to the government?

Student Loan Interest Deduction: Conclusion

Thanks for reading my opinion on the matter.  I wanted to draw attention to this student loan interest deduction information so you our readers were advised and could perhaps take it into account when considering anticipated refunds, etc.  As always with this more technical type of stuff, let me know if I am wrong in any way.  As I said before, I am not a tax expert.  Please do not rely upon this as tax, financial or any other type of advice.  Instead seek a proper expert.

Comments Requested:

I want to know if people think my opinion is off base.  So, please let me know: does anyone think I am really really wrong about this?  I am sure plenty of people do and I’m looking forward to hearing about it.  Truth be told, if my opinion is wrong, then I’m wrong, and perhaps you can persuade me and change my mind.

Thanks again to Jeff for writing in with the timely post idea.  Everyone in the U.S., if you haven’t done so yet start getting those tax returns in they are due soon.

 

{ 18 comments… read them below or add one }

1 Philly area March 9, 2011 at 12:22 pm

I could not agree with you more. I remember when student loans became deductible. We could barely pay the heating bill and yet we were over the income limit so we didn’t quality.

That’s when I began to see that the tax code was stacked against the little guy who wanted to make something of himself. And it cuts across both parties – the Kennedys and Bushes, they don’t need to worry about student loans. And poor people, well, they don’t pay taxes so long as they stay poor .

The tax code is stacked against people who started with nothing but are now earning over 150k. Take, for instance, the capital gains tax. The rich can live off their capital gains. But regular Joes like us who had student loans – we’re lucky just to have a savings account but of course that interest income does not qualify as capital gains and we need to pay at the 36% tax rate (or whatever the tax rate is).

In truth, we’re finally at a point where we do own investments, but it was many, many years into being 150k + earners. And don’t get me started on the Roth, or the AMT, or the deduction phaseout limits or the…

The really, truly rich don’t pay much in taxes. The poor don’t pay taxes. It’s the HENRY’s (high earners, not rich yet) who have the tax burden on their shoulders. And there can be no doubt it’s weighing us down.

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2 Mr. Broke Professional March 9, 2011 at 11:58 pm

Philly Area,

You always provide the most insightful and detailed comments. Sometimes I feel bad because I feel like I do not have much to add to them, because you pretty much say everything I want to say. I think you guys are a few years ahead of us, and I hope we can be where you are when the time comes. I think it’s true that a lot of the weight of this country rests on the middle class’s shoulders. Hopefully we have a broad enough shoulder to handle that pressure. I am sure you have read about all those fortune 500 companies that do not pay taxes or pay very little in taxes. Of course that may help promote job growth, but sometimes it does seem unfair. Particularly with the trust fund baby types and all the tax breaks for that. Nothing you can do but try and stay informed and keep working until you are rich enough to have trust fund babies of your own, I guess. lol.

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3 Miss T @ Prairie Eco-Thrifter March 9, 2011 at 1:55 pm

This doesn’t surprise me. Most government perks seem to have an income cap, at least where I live. The middle class get penalized for doing well. Pisses me off. But then again, I guess I can afford things that others can’t so I guess it’s a catch 22.

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4 Nicole March 9, 2011 at 9:45 pm

I’m getting out my tiny violin. Sorry!

Also, even if I weren’t busy crying me a river, who on earth said the tax code was supposed to be fair (not that I’m saying you’re being harshly penalized… though I do agree that the capital gains tax should be higher)? That’s a common misconception. “Fairness” is a waste of money (which would require a heck of a lot more taxes). One of these days I’ll get around to finishing our post on the reasons for government intervention so I can link to it, but fairness isn’t one of the reasons. It’s all about fixing market failure. In this case, the government thinks that credit market failures and positive spillovers justify encouraging people to get more education through the promise of future tax breaks.

And encouraging you to take even more loans out if you’re expecting to earn a lot isn’t actually fixing market failure… sounds like you think you already over-invested in your education. Bigger tax breaks might have encouraged you to go in the hole even more. Then there would be even more underemployed lawyers competing against you. Really what you’re arguing is that there should be no tax breaks at all because people are getting too much education and we don’t want to encourage that. I disagree with that argument, though perhaps *all* professional degrees should be exempt from the tax break, as there really are too many lawyers and MBAs and so on.

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5 Jeff March 10, 2011 at 8:58 am

Nicole, is it fair to say you are not one of the many “many lawyers and MBAs and so on”?

You are right, there are too many professionals that over invested in their education. However, I don’t think the young-professionals should get all the blame.

The issue is that college education costs, even undergraduate, are way too high. They have increased much faster than inflation. In addition, many professions now require extra years of education to obtain a degree.

I just don’t understand how a twenty-something with six figure student loan debt can be considered “rich” and penalized when it comes to taxes.

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6 Paul March 22, 2011 at 2:28 pm

An individual pushes oneslef not to stop after highschool and have 2.5 kids in 4 years. They aspire past college and go on to get a doctorate degree, in spite of the fact that academics have always been tough on them and never able to have a high GPA with ease like certain gifted and talented students.

That person strived while others took a quicker way out. However, lets not fail to mention, that if that individual made it 1/2 way through school and couldn’t pass like many others, no one would help him/her with the nearly $100,000 in loans already accumulated.

That person graduates works hard and gets an income up to right at $80,000. They negate now any tax break they could of had. They fall into a higher tax bracket, because they are “rich”, so therefore they should have to pay off more of the country debt than the people who chose to do what they wanted earlier in life and don’t have as much income. They have $10,000 – $15,000 per year for 10 years of debt already to pay back, without any exemption.

I can tell you this. That individual will pay their taxes, pay their tuition debt, and aspire because problem solving difficulty is what they do.

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7 Mr. Broke Professional March 22, 2011 at 2:47 pm

True. But is it fair?

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8 Patrick in the Midwest October 27, 2011 at 11:32 am

I would find myself in a similar situation if my wife had continued her education. This particular tax code is particularly aggrivating to me. I am a Mechanical Engineer and borrowed to attend a very good engineering school so post college I could dive right into my career. I earn enough to have the $2500 become prorated single, but as a couple we are under the cap. We both have school loans to pay off. Last year we paid three times the allowed deduction in student loan interest. It seems excessive to allow each of us to deduct $2500 when single, but when we decided to get married we are penalized. With recent talk of student loan borrowing rate reforms, it has made me wish that they would take the time to reform the tax law. With increased emphasis on higher education for even the most modest professions, more and more people will be falling into this problem. Its unfortunate to the point I envy friends who didn’t persue higher education, who have gainful employment but don’t earn a higher salary, but who have more descretionary income, and receive greater tax benefits than us. Maybe in 20 years when all our student loans are paid off it won’t even be a fleeting thought. But right now it feels like a penalty for striving for more.

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9 Adam February 13, 2012 at 1:56 pm

Nice article. Just did my taxes for the first time post graduate. Had no Idea I could not write off the huge portions of interest I paid towards my student loan. That is garbage. Because they are government loans, is the government not “double dipping” into my hard work? I almost think it would be better for my wife to quit work and not be over the “magical” $150,000 mark that deems me “rich”. Sometimes I think my country is ran by monkeys, who parade around this fairness ideal that in practice is the exact opposite of fairness. It’s class warfare. I should not be punished for doing well. I owe $750 every month for 30 years, a total of over $100,000 ( it may be more, I am just taking a stab) in just interest(to the government) that I cannot write off. Garbage. After ALL my taxes and government loan payments I take home almost half what I make. Why can’t everyone just pay the same percentage and there be no write offs? Certainly would seem fair to me. 10% of a million is $100,000, 10% of $100,000 is $10,000. The rich still pay more.
/rant

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10 Nick March 3, 2012 at 9:41 am

I have been thinking about this issue a lot lately (and every year around this time). Student loans are considered “good investments” because they lead to higher education and better jobs. It is true that graduating from law school or business school will open doors to more opportunities and potentially higher wages. But as tuition continues to rise at rates far greater than the national income, the reality is that the cost of higher education can outweigh the benefits.

One answer to the problem of the rising cost of higher education is to reduce tuition rates. Making school more affordable would not only make it easier for graduates to pay their monthly loan bills, but would encourage students to consider a wider range of job opportunities out of school (as opposed to, say, big law or wall street). However, private schools have little incentive to slow the growth rate of tuition so long as there are students willing to pay (read: borrow).

The better answer to the rising costs of higher education is through the tax code. The tax code is filled with “carrots” that encourage taxpayers to behave in certain ways. For example, the tax code encourages us to open individual retirement accounts (contributions can be deducted), donate to charity (deductible), and own a home (mortage interest is deductible).

Just as this country puts a premium on saving for retirement, charitable giving, and home ownership, so too does it promote the education of our society. The tax code should treat the debt associated with higher education accordingly. For many graduates of business and law school, the burden of a student loan is equivalent to having a mortgage. The current cap on student loan interest deductions makes it impossible for most graduates to deduct any interest. At the same time, these people cannot afford a mortgage payment as a result of their student loan obligations.

The cap on qualifying income for student loan interest deductions must be increased significantly, or else eliminated. The debt burden that follows graduates is preventing them from contributing meaningfully to the economy and discouraging prospective students from borrowing for higher education. Allowing people to deduct the full amount of student loan interest paid in any given year will alleviate the heavy debt burden that has become synonymous with higher education.

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11 Amanda DMD April 5, 2012 at 9:19 pm

Last night I did my taxes for my husband and I, and literally burst into tears when I saw that we owe $6,000 in taxes. We simply don’t have the money. We have no savings — at all. We live month to month, and we do not spend on any luxuries — ever. If we eat out, it is only at cheap restaurants. I never buy new clothes, ever. We can’t even afford to go on vacation. We just bought a home this year, but if anything ever went wrong — any repairs were needed, we would not be able to afford to fix it. On paper, our gross income is over $150,000 a year combined. But in truth we make far less. I am a new graduate of dentistry. My student loan debt is $300,000. I paid $44,000 in student loan debt in 2011 — $37,000 of that was interest alone. I moved 100 miles away from my husband (and his place of work) in 2011 to work at a community health center which was listed on the National Health Service Corps website, to fill a vacancy which qualified me for loan repayment. Now we are maintaining two separate households. He rents a small room near work, and we bought a home near the community health center because it was a much more affordable area to buy. I applied 3 months before the deadline for the NHSC loan repayment program in 2011. But, guess what, the NHSC ran out of money in 2011. And I did not get any money. Now, they’ve changed the stipulations, and my health center does not rank highly for loan repayment. I will likely not receive loan repayment in 2012 or ever in the foreseeable future. But, now we are tied to our new home near this health center. Because we are in the ‘rich’ tax group, not only do I no get a tax break for student loan interest, we also do not get a tax break for mortgage insurance premiums. There is also tax allowance for being married — and living 100 miles apart, having to pay 2 separate sets of living expenses. It’s stupid that you pay more taxes if you are married!

I literally feel so angry I could scream. I feel that I have worked incredibly hard to fulfill a necessary role in our society, providing much needed care to the underserved. (Who mostly have state benefits that provide them with free dental care — I don’t even have any dental insurance myself. I have not had dental xrays or a cleaning in 2 years — and I am a dentist!) I agree with Adam above. I do feel the government is double dipping — charging me 8% interest on student loans, and then also taxing me on the interest. It makes me sick. I seriously want to leave this country.

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12 Jen April 9, 2012 at 9:53 pm

This issue has long-since been a pet peave of mine. I am a lawyer, and I graduated law school in 2007—back when the myth of $100k+ jobs as the norm–even outside of the big cities–was still alive and well in schools. I graduated, however, into a different reality.

In some respects, I faired quite well compared to my peers. I got and kept a job (though I am still earning much less than I thought I would). I only took out about $100k in student loans, for a total of 4 years at a private liberal arts college, and 4 years at a private law school. $100k sounds like a lot, but that’s less than half of what a friend of mine who went to the same schools without the scholarships I had paid.

Notwithstanding, how “lucky” I should feel, I feel like I am getting perpetually screwed by student loan interest, all of which is “federal.” I see two major problems with this system, and one that I don’t think anyone pointed out yet.

1. You can’t re-negotiate or reconsolidate federal student loans once you consolidate the first time. That means, while homebuyers and other debters can take advantage of market lows, or recession economics, federal student borrowers cannot. This is patently unfair, and should be rectified.
– My story: I attempted to consolidate my loans in 2006, a year before graduation, while there was an “in school” loophole. Did anyone else do this? Interest rates were at 2%, or maybe even less. I called my loan company (Access group) and went through a telephone process. I thought my loans through 2006 were consolidated. Fast forward to graduation in 2007—I learn that they did NOT consolidate my loans to take advantage of the low interest rate at the time. WHY? Because they sent something for me to sign to my parent’s house, and never got it back. Ok, I figured “at least I still have my 1 year federal grace period.” WRONG AGAIN. They did not consolidate my loans because they didn’t get mt “signature,” and could not consolidate with my “verbal authorization only,” but they COULD and DID send my loans into “early repayment” at the time of my telephone authorization, and no I could not take that authorization back. None of this was ever confirmed in writing to me…. Long story short, I consolidated at 7.25%. About $90k in loans at 7.25%, for 30 years. None of the new federal student loan interest rates affect me because I already consolidated. I went to school young, but I will be paying off these loans until just a few years before most people retire. This is not the American dream.

Why can’t I refinance my federal loan like a homeowner can? It seems that only people who graduated around 2007 have this problem, since rates were very low before, and now rates are low again.

I pay my loans on time every month. I work in private practice, but don’t earn that much I choose to forgo cable, home internet, new cars etc, to avoid going into consumer debt. Why don’t responsible young professionals like me/us deserve a break or a bailout?

2. Even though the $2500 deduction is low, it should, at a minimum, be doubled for married/joint filers. Period. There is no logical reason to deny that. I know people whine about equity here, but what I really hate about this is that the fact that the deduction stays the same in a dual income household presupposes that only one spouse went to college (or even worse, that we are back in the 1950s, when only one spouse typically worked). I hate that, because I think it harkens back to the archaic days when only men were supposed to go to school or get advanced degrees. The reality is that in today’s economy, an undergrad degree isn’t what it used to be. People need advanced degrees in many cases to be stable middle class citizens. Men and women both go to school, and both in many instances work, and, (*gasp*) continue to work after marriage, and after children (not necessarily because they like to work, but more likely because they have to pay bills, like student loans). I realize that there are flaws in the cost of higher education, and the system in general, but squeezing those of us victims of the system isn’t the answer.

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13 PLB April 17, 2012 at 4:33 pm

I really enjoyed this article/blog. I have been writing to members of Congress recently asking them to increase the benefits for the student loan interest tax deduction, either by raising the cap on interest or raising the salary cap. It would be great if they could eliminate any phase outs too. I encourage each and every one of you to contact Congress to ask them to take a good look at this issue to see what could be done. It would really help ease the burden of having to pay back high dollar student loans for what seems like a lifetime if I knew that there could be some really great tax benefits at the end of the year.

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14 jd May 25, 2012 at 5:50 pm

This topic has always made me angry. I starting babysitting at 12 and worked my butt off my whole life since. I was the first person in my family or even in my neighborhood to go to college and figuring out how it all worked wasn’t easy. I was smart, skipped 8th grade, but no one guided me after I graduated high school. I worked full time and did what I could until I figured things out. I finally graduated with my undergrad when I was 28 because I had to work full time while going to school at night. To finish undergrad while I worked full time meant I went to a private school that held all the necessary classes at night and on weekends so I could finish. I took classes at community college, but had to transfer for the core studies and state colleges couldn’t help. Private schools were the only way I finished without falling behind in the professional world. Luckily, I was very successful and at 30, I am now CFO for a decent sized investment firm. Still…I pay at least $6k of interest each year and none of it is deductible. I can’t afford to buy a house in Los Angeles while I’m paying this off, so until then, I’m living very modestly and doing my best.
I wish there was something we could do about this. Shouldn’t we be incentivized to do well in life, and does that mean we give up the ability to secure a home?

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15 emg June 10, 2012 at 4:48 pm

Student loan interest rates go up and down & the consolidation rules are arbitrary. Some people are paying 1.8% on their stafford loans while others are paying 6.8% based on the year they went to school. Might as well flip a coin or use a birth-year system to decide what tax bracket you are in.

Jen, your story is different than ours, but getting screwed over by loan servicers is familiar to me. My wife owes > $200K on vet school loans. Getting the facts from these people is impossible. Getting misinformation over the phone is the norm. They did not send any communication to us when our application for IBR was found to be incomplete. When I asked about it, they said that my wife was supposed to log in and check on the application status. Over all, these run-arounds have cost us about $10K over the last year.

My current plan is to try to figure out if there are any tax gymnastics to do (marginal or not) to at least get a deduction on the interest. At the moment, after paying taxes, loans, and commuting expenses, my wife’s salary of $70K will amount to $8,200. If we have kids and pay for child care, we will be in negative territory. That’s a pretty strong incentive to stop working, raise the kids, and get in good physical shape.

Nice blog, by the way.

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16 ADS MD June 19, 2012 at 7:41 am

OK I am going to RANT on my soapbox..

This is the most ridiculous thing in the world. I can’t believe that we are in the highest tax bracket; my wife and I paid over 150K in taxes. I drive a used car, and don’t spend on many luxuries and we have maintained a very moderate lifestyle. I was fortunate enough to have a scholarship for undergrad, but MD school I left with close to 160K, which no after yrs of deferment is 260K.
My father was supposed to help, but died in 2008. The only thing that made sense was to take a home equity LOC or mortgage on his home so that I could at least take the interest deduction. But because he died without a will, I am battling relatives that aren’t even US citizens to take ownership of the house, which has 20K in back taxes due thanks to the lawsuit.

If you don’t have some equity to leverage somewhere, you have ZERO way of dealing with your loans.

Almost anyone that came from a single parent (1 income family) growing up as I did had to take loans, especially if you are in healthcare. But the fact that the government can charge you 36% taxes, and no deductions with the “money they loaned you”.. but wait isn’t some of that my own tax money? This goes beyond double dipping its beyond offensive and is almost indentured servitude.

Oh by the way, did you guys know that any senator/congressman gets their salary for life no matter how many years they served, its only $200K of our tax money. This actually is worse, because fiscally it means that we should elect officials and keep them in as long as we can with little or no turnover?

I think we need to face the fact that the American Dream is dying; that the little guy can only get above the line if he gets rich quick.. Its no wonder that there is a so much greed?

Despite the fact that the economy was tanked by “complex financial instruments” and a housing bubble that was beyond obvious. NOBODY was brought to trial for any misconduct? How is it that billions can be sucked out of the economy through “legal loopholes” and nobody does anything.

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17 paying high student loan interest January 15, 2013 at 7:20 pm

Great rant, I have recently run into this problem and is very frustrating. I am recently married and both my wife and I have high student loans. Our combined interest for the 2012 year is over 5,000 but why is it that we can only deduct 2,500??? That’s kind of an incentive to NOT get married so we can file individual returns and deduct 2,500 each instead of the 2,500 total for joint. And why is it that if we try to file separately but married we can’t deduct any? It seems so unfair to punish the married couple.

Also, I agree with the high earners should be able to deduct more, it’s a very good chance that the individual took out a large loan for that profession. I happen to know several doctors with 100,000 plus loans who can only deduct the max 2,500. I should tell them to not get married either….

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18 Sean McCullough February 2, 2013 at 7:08 pm

Life isn’t fair and most people don’t seem to get that. I am not rich and if anything im a bit above poverty by about a thousand or two. I will still strive to make a lot of money. I’m in nursing school and plan on going on after that for multiple years….only if it will benefit my salary and benefits.
A) The system isn’t set up to make the poor/middle class richer, it is set up to make the rich poorer. This is what liberals/progressives really mean by ‘leveling the playing field’.
B) Most college degrees are absolutely worthless
C) Physical Therapist used to be a bachelor’s degree, then a masters, now a 7 year doctorate. Nursing is 2 years, by 2020 it will 4. Nurse Practitioner was a Masters and in 2015 will be a doctorate/phd (one of the two). The 65 year old nurse will slap the tar out of the nurse with her masters and kick the doc who just got out of Medical school. Experience trumps ‘theory’ and the extra ‘education’ these professionals receive is not much better than garbage in a can. It’s about getting paid. A hospital that says, ‘We’re Magnet status, all of our Nurses have Bachelors degrees etc.’ makes the public feel good inside. People in the know, understand the Bachelors was an online course that didn’t do much. Look, when you’re a nurse you’re a nurse! What does the extra education do as far as being a nurse? Nothing. Know why? You’re already a nurse! It only counts if you try to become a practitioner, anesthetist, mid-wive etc. Then you learn something new and valuable. They keep extending the time it takes to get a degree, not because ‘science is evolving and there is more to know’ garbage it’s because it’s more money. The physical therapist who got his 4 year degree in 1985 will school the guy who has been a PT for 3 years with a doctorate. Most of the public will say, ‘are you stupid’? I say nothing. Their question lets me know they don’t know about ‘real life’ and how it works. Jeff, im getting back more than you but one I will make as much or more than you (i say that respectfully) and I to will get cheated for hard work and dedication. I will then send my message of ‘fairness’ as you are. One thing is for sure, as I complain, I will know that no one owes me anything and I got to where I was because of hard work. Good Luck to everyone.

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