Deducting interest on qualified education loans.

• Author: Ellentuck, Albert B.

Interest due and paid on a qualified education loan for qualified higher education expenses can be deducted (within limits) from adjusted gross income (AGI) (Sec. 221(a)). The deduction is an above-the-line deduction, so it is available regardless of whether a taxpayer itemizes deductions. Married taxpayers must file a joint return to claim the deduction, and no deduction is allowed to an individual if that individual is claimed as a dependent on another taxpayer's return for the tax year (Secs. 221(e)(2) and (c)). The maximum amount of interest a taxpayer is permitted to deduct is $2,500, regardless of how many students are in the taxpayer's family (Sec. 221(b)(1)).

The maximum allowable deduction phases out ratably when a taxpayer's modified AGI exceeds certain amounts. Modified AGI is AGI without the deductions for education loan interest, qualified tuition and expenses, and domestic production activities and without the exclusions for (1) foreign earned income and housing costs and (2) income from certain U.S. possessions and Puerto Rico (Sec. 221(b)(2)(C)). For 2008, the deduction phases out ratably as modified AGI moves from $115,000 to $145,000 for married joint filers and $55,000 to $70,000 for single and head-of-household filers. The phaseout ranges are subject to annual inflation adjustments.

Example 1: H and W file a joint return in 2008. Their modified AGI is $125,000. Before considering the modified AGI limitation in 2008, they are entitled to a $1,000 student loan interest deduction. However, they are $10,000 ($125,000 - $115,000) into the $30,000 phaseout range for joint filers, so their student loan interest deduction for the year is limited to $667 [($30,000 - $10,000) + $30,000 x $1,000].

Planning tip: The rule preventing claimed dependents from taking the deduction prevents parents who cannot claim the deduction because their income is too high from shifting the deduction to the student/child by having the child take out the education loan. However, a person (student) may claim a deduction for interest paid in later years when that person no longer qualifies as a dependent. Therefore, it may make sense for the student/child to take out the loan when payments will not be due until after graduation, at which point the child will presumably no longer be a dependent.

Only the taxpayer legally obligated to make interest payments under the terms of the education loan can claim the student loan interest deduction (Regs. Sec. 1.221-1 (b) (1)).Therefore, parents cannot...