Deduction for interest on qualified higher education loans
There is now a new type of deductible interest: interest on qualified education loans. The deduction applies to interest due and paid after 1997, on loans taken out
on, before, or after August 5, 1997. Thus, you may qualify for this deduction for interest you pay after 1997 on existing loans.
The deduction is a departure from the general rule that interest on "personal" loans is not deductible (except, in most cases, for mortgage interest on your home).
Here are the requirements for deductibility: The maximum amount of interest you can deduct is $2,000 in 2000, and $2,500 in 2001 or later. The
maximum isn't adjusted for inflation. However, the deductible amount is reduced for certain high adjusted gross income (AGI) taxpayers, as explained below.
The interest must be for a "qualified education loan," i.e., for a debt incurred already to pay tuition, room and board, and related expenses to attend a post-high
school educational institution, including certain vocational schools. Certain post-graduate programs also qualify. Thus, an internship or residency program leading to
a degree or certificate awarded by an institution of higher education, hospital, or health care facility offering post-graduate training can qualify.
Only interest paid during the first 60 months that interest payments are required can qualify. Months in which payments aren't required, e.g., during a deferral or
forbearance period, are not counted against the 60-month period. In the case of an already existing loan, interest payments qualify for deduction to the extent the
60-month period hasn't expired. But months during which interest was paid before January 1, 1998 would count against the 60-month period. For this purpose, a
loan and all refinancings of the loan are treated as a single loan.
Since the 60-month period (i) may have started before the interest deduction was available, (ii) only includes months during which interest payments are required,
(iii) may have been suspended for a period, and (iv) may cover refinanced loans, it may be confusing to determine when the period starts and ends.
Example: On March 1, 1996, a taxpayer borrowed funds to finance his son's education. No payments were required on the loan until January 1, 1997, at which
time only interest was paid. From January 1, 1997, to February 28, 1998, no payments were required under the loan. On March 1, 1998, payments of interest and
principal started being made. In determining the 60-month period, counting only begins on January 1, 1997, when interest payments started. Also, the months within
the suspension period are not counted. Accordingly, only five months in 1997 are counted (January through May) and only 10 months in 1998 (March through
December). Thus, as of the start of 1999, 45 months out of the 60-month period remain.
IRS hasn't yet explained yet how the 60-month rule applies to multiple qualifying loans that have been refinanced by, or are serviced as, a single loan. Please
contact our offices if we can help you determine the qualifying period that applies in your case.
The deduction is only fully allowed for taxpayers (married filing jointly) with AGI of $60,000 or less. For taxpayers with AGI of $75,000 or more, no deduction is
allowed. If the AGI is between $60,000 and $75,000 the deduction is partially reduced, depending on how far above $60,000 the taxpayer's AGI is. For example,
if AGI is $65,000, the deduction is reduced by 33 1/3% since the $5,000 excess above $15,000 represents 33 1/3% of the $15,000 excess that would result in
complete disallowance. For other taxpayers, e.g., single taxpayers, a full deduction is allowed if AGI is $40,000 or less, no deduction is allowed if AGI is $55,000
or more, and a similar partial disallowance approach is taken where AGI is between $40,000 and $55,000. (For these purposes, AGI is computed with certain
modifications, e.g., the exclusion of income from U.S. savings bonds used to pay higher education costs is not taken into account.) The $60,000 (and $40,000)
"phase-out" amounts discussed above will be adjusted for inflation for years after the year 2002.
Married taxpayers must file jointly or no deduction is allowed. Also, no deduction is allowed to a taxpayer who can be claimed as a dependent. That is, in the
typical situation where a parent is paying for the college education of a child whom the parent is claiming as a dependent on the parent's return, the interest
deduction is only available for interest the parent pays on a qualifying loan, not to any interest the child/student may pay on a loan the student may have taken out.
(The child could claim the deduction later, when the child is out on his or her own, and no longer a dependent).
Where a deduction is allowed, it's taken "above the line," i.e., it's subtracted from gross income to determine AGI. Thus, it's available even to taxpayers who don't
itemize deductions.
Other requirements
The interest must be on funds borrowed to cover qualified education costs of the taxpayer or his spouse or dependent. The expenses must
be for education furnished while the recipient was an "eligible student," i.e., at least a half-time student. Also, the education expenses must be paid or incurred within
a reasonable time before or after the loan is taken out. Taxpayers must keep records to verify qualifying expenditures. Documenting a tuition expense isn't likely to
pose a problem, but care should be taken to document other qualifying expenditures such as for books, equipment, fees, and other education-related costs such as
transportation.
Documenting the costs of room and board should be straightforward for the most part for students living and dining on campus. But where the student lives off
campus, records on the costs of room and board should be maintained, especially when there are complicating factors such a roommates involved.
If you would like to discuss this further, or have questions or concerns, please feel free to contact our office.
|
