Student Loan Tax Credits Guide

Learn about the various tax credits and deductions you can avail on your student loans and which one to opt for to get the maximum benefit.

Updated by Heibha Passah on 12th June 2019

All you need to know about Student Loan Tax Credits 

Student loans can help you out with funding education but it can be quite expensive. The payments have to be made every month which will decrease the amount of wealth you have.

Even though it may sound like a huge burden, which it is, there are a number of deductions and tax credits available on your student loans which you can take advantage of, to reduce your taxable income like the student loan interest deduction and two other tax credits which will help reduce the amount of taxes to be paid like the American Opportunity Tax Credit and the Lifetime Learning Credit.

It is always a good idea to claim the deductions and credits you are eligible for, as it will help you save a whole lot of money.

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Table of Contents


Tax Credits on Student Loans

As mentioned above, there are two tax credits available on your student loans which you can take advantage of, to reduce the tax payable on your taxable income.

The eligibility criteria to claim these credits depends upon whether you are still in school, paying your tuition or whether you’re out of school and have already started repaying your student loans.

1. The American Opportunity Tax Credit (AOTC)

The AOC allows you to reduce up to $2500 per year from your tax liability for the first four years while you’re still in college. It can be refunded back at 40% of the leftover credit amount up to a maximum of $1000 if after claiming credits your tax liability becomes zero. So you can receive up to $1000 as a refund if you have a tax liability of zero.

Eligibility Requirements to claim the AOTC

  • You should be pursuing college which will lead to getting a degree or any other recognized qualification.

  • You should be enrolled for at least half time or one academic period.

  • You should not be completing your studies before 4 years, as it is applicable for the first four years of college.

  • You are not allowed to claim the credit for more than four years.

  • You should not have any drug felony convictions.

  • For claiming the full credit, you should have a Modified Adjusted Gross Income (MAGI) of $80,000 or less and $160,000 or less for a married couple who are filing jointly.

  • For partial credit, your MAGI should be not more than $90,000 and not more than $180,000 for married couples.

  • You (if you are a taxpayer) and the student should have valid social security or tax identification number on the due date of filing the tax return.

Eligible expenses for AOTC

Tuition and fees paid to an eligible educational institution and also any post-secondary school that pertains to the conditions to take part in the US Department of Education financial aid program.

These fees include the cost of books, supplies, equipment or any purchases made by the student relating to the course he/she is pursuing.

The expenses to be paid during the taxable period should relate to -

  • An academic period that started in the same taxable year, (or)

  • An academic period that starts in the first three months of the next taxable year.

How to claim AOTC?

For claiming AOTC, if you are the one paying tax (or are dependent) then you have to get a Form 1098-T, a Tuition Statement from an eligible educational institution, either domestic or foreign by January 31. This statement will help you find out your credit. Box 1 in the form will show you the amounts you have received during the year but the credit can be claimed only on the qualified expenses.

Also, make sure to have your required documents as proof to show that you have really qualified for the credit.

You should also have your Form 1040 which is your personal tax return, so a Form 8863 should also be completed and attached to your 1040.

Calculation of AOTC amount

The credit amount will be 100% of the first $2000 of the amount you spent on qualified expenses plus 25% of the next $2000 you spent again but the limit will be $2500 per annum per student.

Only one credit can be claimed per year by one student. So if there are two eligible dependents then one can claim this credit, while the other has to take a different credit option. Also, you can claim only one tax credit per year for one student.


2. Lifetime Learning Credit (LLC)

LLC allows you to claim up to $2000 per year from your tax liability for any number of years as there is no limit on that. Unlike the AOTC, it is non-refundable so it’ll only help with reducing the tax liability to zero, and no part of the credit can be refunded back to you.

Students going for undergraduate, graduate, professional degree programs or courses which will help improve your job skills can get help with paying for their education using this credit.

Eligible persons to claim the LLC

  • You, your dependents like spouse, or any other third party that you’ve listed in your tax return paying higher education qualified expenses.

  • You paying the qualified educational expenses for a student attending an eligible educational institution.

  • You are attending a higher education institution for the purpose of acquiring a degree or any other recognized qualification or to improve job skills.

  • The student has to be in college for at least one academic period starting in the taxable year.

  • For claiming the full credit, you should have a Modified Adjusted Gross Income (MAGI) of $57000 or less and $114000 or less for a married couple who are filing jointly.

  • For partial credit, your MAGI should not be more than $67000 and not more than $134000 for married couples.

What is an Eligible Educational Institution?

All accredited colleges, universities, trade school or other post-secondary educational institutions eligible to take part in the US Department of Education student aid program. These institutions can be public, non-profit and private for-profit post-secondary institutions.


[Also Read: All you need to know about For-Profit Vs. Not-For-Profit Colleges ]


What are Qualified Educational Expenses?

The amount to be paid for tuition, fees or any other expenses of an eligible student made for enrolling at an eligible educational institution. Also, expenses incurred for sports, games, hobbies non-credit courses will qualify if it helps the student obtain or improve job skills.

The expenses to be paid during the taxable period should relate to-

  • An academic period that started in the same taxable year. (or)

  • An academic period that starts in the first three months of the next taxable year.

Any student activity fee paid to attend a school will also be eligible. For example, a student activity fee to fund the on-campus organizations of the students and activities.

How to claim LLC?

For claiming LLC, if you are the one paying tax (or dependent) then you have to get a Form 1098-T, a Tuition Statement from an eligible educational institution, either domestic or foreign by January 31. This statement will help you find out your credit. Box 1 in the form will show you the amounts you have received during the year but the credit can be claimed only on the qualified expenses.

Also, make sure to have your required documents as proof to show that you have really qualified for the credit.

You also have your Form 1040 which is your personal tax return, so a Form 8863 should also be completed and attached to your 1040.

Calculation of LLC amount

The LLC amounts to 20% of the first $10,000 that you spent on tuition fees per year at a maximum limit of $2000. It also depends upon the amount of the qualified expenses in order for you to claim the whole $2000 credit.

For example - 

You spent only $6700 on your qualified expenses, so the amount of credit you can claim will be 20% of $6700 which is $1340. As it is non-refundable, the amount you didn’t use ($2000 - $1340 = $660) will not be refunded back.


Who cannot claim Tax Credits on Student Loans?

You won’t be able to claim tax credits on your student loans if -

  • You are listed by someone, such as your parents, as a dependent on their tax return.

  • You file your returns separately and your filing status is married.

  • You already claimed another tax benefit on the student loans of the same student and the same expenses.

  • You or your spouse were non-resident alien for any part of the year and did not opt for being treated as a resident for tax purposes.


Expenses that do not qualify for Tax Credits on student loans

If you’ve paid the following expenses to attend an eligible educational institution, the following won’t qualify for the tax credit on your student loans.

  • Room and board

  • Insurance

  • Medical expenses, including student health fees

  • Transportation

  • Similar personal, living or family expenses

  • The fees paid which are not required as a condition for enrollment.

  • The same expenses paid with tax-free educational assistance.

  • If the same expenses are used for claiming any other tax deduction, credit or educational benefit.

Expenses incurred for sports, games, hobbies non-credit courses don’t qualify for AOTC.


The American Opportunity Tax Credit vs Lifetime Learning Credit

The following shows the differences as well as the similarities between the two tax credits so that it’ll be convenient for you to compare them and see which one is more preferable-

Basis AOTC LLC
The maximum amount of credit Up to $2500 per year per eligible student. Up to $2000 per year per return.
Refund status 40% of the credit. Non-refundable.
Limit on MAGI for a married couple filing jointly $180000. $134000.
Limit on MAGI for single, head of household or qualifying widow(er) $90000. $67000.
Can married filing be filed separately? No.  No.
Dependent Status If someone listed you as dependent on their returns, you are not eligible for claiming tax credits. 
Should you or your spouse be a US citizen or resident alien? Yes, unless they opt to be treated as a resident for tax purposes. 
Number of years to remain in college to qualify for credit 4 years. Unlimited.
Required program Pursuing a degree or other recognized educational qualification. The student doesn't necessarily need to be pursuing a degree or other recognized educational qualification.
Number of courses The student has to stay in college for at least half time or one academic period Students can be available for one or more courses.
Conviction of Drug Felony The student should not be convicted. It doesn’t apply.
Qualified expenses Tuition, fees for enrollment and other supplies needed for the course. Tuition and fees for enrollment.
The benefit can be claimed for whom? You, your spouse, or the student listed as dependent on your return. 
The qualified expenses are paid by whom?

 You or your spouse, student, or any third Party. 

Payments for academic periods Academic period for the taxable year or first three months of the following taxable year. 
Does credit need to be claimed through a form? Yes, through Form 8863.  Yes, through Form 8863. 

Student Loan Interest Deduction

When repaying student loans, we are actually paying the principal amount along with the interest charged on the loan. This can be quite costly but with the benefit of claiming deduction on this interest, you can reduce the interest payments on your student loans from your taxable income up to $2500 a year.

Eligible borrowers will be able to take both the interest deduction along with the standard deduction, which means you do not need to itemize your deductions.

Eligible persons to claim the interest deduction - 

  • You, your spouse or your dependent making qualified educational expenses.

  • You are attending college at least half time which will lead to you acquiring a degree or a recognized educational qualification from an eligible educational institution.

  • You have made interest payments in under the past tax year for your qualified student loan.

A qualified student loan is a loan taken either for you, your spouse or your dependent just for the purpose of funding academic expenses during the academic year and the interest deducted must be incurred under a reasonable time period prior or after the loan was taken.

  • You are obliged legally to pay the student loan.

  • You are a married couple not with a filing status of filing jointly.

  • You are not listed on someone else’s, such as your parents, tax return as a dependent.

  • You have Modified Adjusted Gross Income (MAGI) of less than $80000 and $165000 for married couples filing jointly.

Loan not qualified for the interest deduction

Any loan which you got from a related person will not be a qualified loan and interest will not be deductible. Related persons can be your-

  • Spouse

  • Brothers and Sisters

  • Half brothers and sisters

  • Ancestors

  • Lineal descendants

  • Certain corporations, partnerships, trusts, and exempt organizations

Any interest on a loan made under a qualified employer plan or under a contract purchased under such a plan will not be deductible.


[Learn more about Student loan interest deduction, AGI, MAGI, and more ]


Qualified Educational Expenses

These are the expenses which make up the total amount paid for attending an eligible educational institution and are eligible for interest rate deduction. They include the following -

  • Tuition and fees

  • Room and board

  • Books, supplies, and equipment

  • Other required expenses like transportation

The expenses incurred for room and board will qualify only if it is less than -

  • The room and board allowance which is determined by the eligible educational institution and is a part of the cost of attendance (for Federal Financial Aid purposes) for a specific academic period and arrangement for a living of the student; or

  • If it is greater, then the amount that is actually charged if the student is living in a house owned or operated by the eligible educational institution.

What is an eligible educational institution?

All accredited colleges, universities, vocational school or other post-secondary educational institutions eligible to take part in the US Department of Education student aid program. These institutions can be public, non-profit and private for-profit post-secondary institutions.

Certain educational institutions located outside the United States but are qualified to take part in the US Department of Education Federal Student Aid (FSA) programs are also eligible educational institutions.

It can also include institutes which are providing internship or residency program for the purpose of acquiring a degree or certificate from a higher education institution, hospital or health care facility that offers postgraduate training.

How to claim deduction on interest payments?

For claiming interest deductions on your loan, you need to receive a form called 1098-E which shows the total interest payable for the taxable year. This interest amount payable will have to be written on line 33 of your Form 1040, which is your personal tax return. 

It will lead to a reduction on your taxable income which will show up on your adjusted gross income in line 37 of the 1040 form.

Calculation of deduction on interest payments

The deduction on your student loans is usually $2500 or the actual interest paid during the year, whichever is less.

But, based on your filing status or MAGI the amount of deduction can be reduced or eliminated.

The interest rate deduction on the student loans will be phased out (gradually reduced) if your MAGI is between $65,000 and $80,000 and between $135,000 and $165000 for married couples filing jointly. If your MAGI goes beyond $80,000 and $165,000, then you won’t qualify for interest rate deduction.

Are refinanced student loans eligible for interest rate deductions?

Refinancing your student loans will get you a new loan with terms and most likely a new interest rate. You might think will this new loan be eligible for interest deductions? Well, Yes.

The refinanced loan, as long as it is used for making qualified educational expenses, will surely qualify for interest rate deductions.


[ Learn more on Student Loan Refinancing


If a loan is refinanced for more than the original value of the previous loans and the extra money is not used for making qualified educational expenses, then the loan will not qualify for interest rate deductions.


Claiming all the tax credits and deductions on student loans

As discussed above, only one of the tax credits can be claimed by each qualified person every year, so make sure you opt for the best one that will give you the maximum benefit. 

These credits and deductions can really help you save money and also reduce your tax liability. 

Keep all the forms you've received which are needed to be submitted when claiming these benefits in a proper manner so that it'll be convenient for you. 

You’ve taken the loan to finish your education and working hard to make repayments for it, so make sure to take advantage of the options available to you.


FAQ's

  Does an expenditure for a computer qualify for the American Opportunity Tax Credit (AOTC)?


It depends upon the factors like, if the computer was acquired as a condition of enrollment or attending the college, then yes, it would qualify for AOTC.

  What is 'modified adjusted gross income' for the purpose of the American opportunity tax credit?


The taxpayer’s adjusted gross income plus foreign income which was not included earlier and also the income excluded from sources in Puerto Rico or certain US possessions.

  Can I claim Lifetime Learning Tax Credit Without 1098-T?


Yes, the student/taxpayer can still claim LLC without receiving a 1098-T form from the institution.

  Do I need to file a tax return?


If you earn more than $12,000, then you need to file for return even if you are listed in your parents' tax return as a dependent. If you don’t, then you’ll be penalized by the IRS (Internal Revenue Service) at 25% or more in taxes and won’t be given the right to claim any refund which you were qualified for earlier.

  How do I file a tax return?


Tax returns can be easily filed by using online tax software that will guide you through each section of your return and also help you to decide which student loan tax credit or deduction to opt for.

  What documents do I need to file my taxes?


The following are the documents you require when filing for tax returns-

Form W-2 - This is a wage and tax statement you receive from your employer.

 Form 1098-T - This is a tuition statement you receive from your school if you are a student.

Form 1098-E - This is a statement showing your interest payments you made on your student loans for the past year.

Make sure to safely keep all the receipts that you get on your educational expenses like tuition fees, books, and also records of your taxable scholarships or fellowships for proof of the amounts you report on your tax return.

  Are student loans deductible in 2018?


Yes, student loans have interest deduction up to $2500 for the 2018-19 taxable year.

  How do student loans affect your tax return?


Your student loan debt can affect your tax return in the following ways-

  • Your taxable income can be deducted up to $2500 as interest payments.

  • If you are married and you and your spouse do a joint filing of returns, then it would increase your student loan payment.

  • If your loans are forgiven, later on, your tax liability will increase.

  Can I get my tax refund back from student loans?


If you opt of AOTC and the amount of your tax liability is less than your credit, then you can get a refund on the remaining amount.

  Will I still qualify for credits if I withdraw from a class?


If any amount is not refunded, then you can claim credits on that amount if you withdraw from the class.