For many healthcare professionals, the student loan interest deduction has become nothing more than a cruel irony. Basically, when you can deduct it, you're not paying it. And when you're paying it, you can't deduct it.
The Basics
Each year, individuals are allowed to deduct up to $2,500 of student loan interest paid. You can claim this deduction whether you itemize or not.
If you're married, your combined student loan interest deduction is limited to the same $2,500 that a single person can claim. Filing separately from your spouse won't help you get around this rule, since no student loan interest deduction is allowed for married couples who don't file jointly. When people refer to the marriage penalty, they are talking about rules like this one.
Wondering how you'll know how much student loan interest you pay each year? During January, each of your loan processors is required to send you a Form 1098-E reflecting the interest you paid to them during the prior calendar year.
Phase-Out
A huge pitfall to this tax break is that you can only deduct your student loan interest if your income falls below a certain threshold. While the phase-out range for 2007 has increased by $5,000 over the prior year, most healthcare professionals who have completed their training will find that their income is too high to qualify.
Single individuals begin to lose out on this tax break once their income exceeds $55,000 (in 2007). The student loan interest deduction is completely phased out once an unmarried person's income exceeds $70,000. For married couples, the 2007 phase-out range is double those amounts, or $110,000 - $140,000.
| | Single Individuals | Married Couples |
| Phase-out begins | $55,000 | $110,000 |
| Phase-out ends | $70,000 | $140,000 |
The phase-out calculation is fairly straightforward. If your Adjusted Gross Income (AGI) falls within the applicable range, you lose out on that percentage of your student loan interest paid during the year equal to where your AGI falls within the $15,000 ($30,000 for married couples) phase-out range.
Let's assume you're single, and your AGI is $65,000. Since your AGI exceeds the $55,000 threshold by $10,000, and the phase-out range is $15,000, you'll only be able to deduct one-third of the first $2,500 of student loan interest paid. If you paid more than $2,500 in interest during the year, you would claim $833. Otherwise, the total interest reflected on all your 1098-E's would be cut by two-thirds.
Pay or Defer
The second source of this cruel irony is that while you're in your training, the bulk of your student loans are most likely in deferment. So during those years that your income falls below the relatively low threshold, you're not required to make any payments towards your student loan debt. No payments equal no deduction.
Should you consider making payments towards your student debt while your loans are in deferment? Even though money is probably very tight, paying some of your loans each year might cut your income tax bill, and will also reduce the amount of unpaid interest that will be added to your student loan nut when your loans come out of deferment.
The $625 Question
Since this tax break is a deduction, the taxes you save are based on the amount you can deduct multiplied by your marginal tax rage. Let's say you're in the 25% tax bracket, and you paid more than $2,500 of student loan interest. Assuming your income is low enough so you can take full advantage of this deduction, you'll end up saving $625 ($2,500 * 25%) in federal income taxes that year.
There are many variables to consider when deciding whether it makes sense for you to pay your student loans while you're still in your training. For more information and strategies regarding your student loan portfolio, check out http://www.GradLoans.com.
