“Student loan interest is deductible” they say. Makes it sound like taking out student loans is such a good deal! But is it really such a good deal? I did the math to find out…

The IRS hasn’t updated its website yet, but according to the tax wizards at H&R Block, the same student loan interest deductions that applied in 2009 will apply in 2010. Great! How much will I save?

If you’re a single filer making less than $60,000, the IRS allows you to deduct the interest that you paid on your student loans, up to $2,500, from your modified adjusted gross income (MAGI).  If you made between $60,000 and $75,000, the deduction is gradually phased out. Not too bad, right? Wrong. Here’s how you’re getting hosed:

  • The deduction applies to your MAGI, not your tax liability. If you are entitled to the whole deduction, for example, you’re not taxed $2,500 less, the government just pretends your income is $2,500 less.
  • You can only deduct interest, not principal, that you paid on your student loans. If you made $6,000 in student loan payments in 2010 but only $1,500 of that was interest, you can only deduct $1,500. Tough nuggies on the rest.
  • If you made over $75,000, this provision is worthless. Do you have $200,000 in student loans but you are only barely making ends meet earning $80,000 in New York City? Uncle Sam doesn’t give a rat’s ass for you.

So how much can this deduction actually save you? If your MAGI in 2010 was $60,000 and that year you paid $2,500 in interest on your student loans, then you would be able to reduce your MAGI to $57,500.  At $60,000, a taxpayer would owe $11,181 in federal taxes; at $57,500, the same taxpayer would owe $10,556, for a maximum whopping savings of…

$625.

Those who earn more or less will save less.

The pitch now rings hollow: “Student loan interest is deductible! Taking out tens of thousands of dollars of debt might just save you $625 on your taxes!”

(Note: None of the information contained in this post is intended to be tax or legal advice. As always, talk to an accountant for assistance preparing your taxes and an attorney for any legal issues.)

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