November/December 1997

Taxpayer Relief Act of 1997 Offers Student Loan Debtors Some Relief

by Brian M. Born

The Internal Revenue Code generally allows deductions for business interest expenses, limited investment interest expenses and qualified mortgage interest payments, but not for personal interest, including student loan interest.  For example, a lawyer who borrowed $50,000 to pay for under-graduate education and law school under a typical student loan program would pay roughly $4,500 in interest the first year out.  Assuming the lawyer entered the work-force in the 28% tax bracket, the fact that student loan interest payments were not deductible cost $1,260.

The Taxpayer Relief Act of 1997 has, appropriately, offered student loan debtors some Relief.  Effective for payments of interest due and paid after December 31, 1997, with respect to qualified education loans, a limited amount of student loan interest is deductible in computing adjusted gross income (this means that taxpayers who do not itemize deductions are still entitled to deduct student loan interest).  However, it is limited.  First, there is a cap on the amount deductible each year as follows:  

Congress also imposed some income limitations.  If you are single and have modified adjusted gross income of less than the $40,000 for a taxable year, you can deduct the full amount of Deductible Interest.  If you are single and have modified adjusted gross income of more than $55,000 for a taxable year, you may not deduct any student loan interest.  If you are single and have annual modified adjusted gross income between $40,000 and $55,000 for a taxable year, the amount of the deduction allowable will be phased-out.  The phase-out is illustrated as follows:  if a single lawyer paid $2,000 in student loan interest in 1998, and whose 1998 modified adjusted gross income was $45,000, he or she would be entitled to deduct approximately $667.  The calculations are:  $1,000 is the maximum 1998 deduction, so it doesn’t matter how much interest was paid in 1998 over $1,000.  The $1,000 allowed deductible interest will be reduced by a fraction equal to the amount of adjusted gross income ($45,000) minus $40,000, divided by $15,000, or 1/3.  Thus, the $1,000 deduction is reduced by 1/3, or $333, resulting in a $667 deduction.

For married couples filing jointly, the deduction is phased-out for adjusted gross income levels between $60,000 and $75,000.  The phase-out levels will be indexed for inflation beginning in 2003.

There are some other rules.  The deduction is allowed only with respect to interest paid on a qualified education loan during the first 60 months (consecutive or not) in which interest payments are required (the clock does not tick during relevant deferral periods).  Note that qualified education loans for which interest payments were required prior to 1998 qualify for the deduction to the extent that the 60-month period has not expired.  For example, if a lawyer began re-paying her qualified student loans on July 1, 1996, 18 months of the 60-month period will have expired on December 31, 1997; however, interest payments for the 42-month period from January 1, 1998 to June 30, 2001 will still qualify for the deduction.

In addition, no double benefit is allowed.  A student who took out a home equity loan to pay for law school could deduct the interest paid on his home equity loan, and, consequently, could not also deduct that interest as student loan interest.  Further, this deduction is not allowed if a dependency deduction is taken with respect to the taxpayer by another person.  Finally, if you are married, you must file jointly to be entitled to the deduction.

Anyone interested in reviewing the new student loan interest deduction provision can find it in IRC 62(a)(17) and IRC 221.  

Brian M. Born is an associate with the Tacoma firm of Turnbull & Associates and the WYLD Trustee for the Pierce District.

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