tax breaks — February 11, 2021

Here’s Why Your Student Loan Interest Deduction May Be Smaller This Year

by Susannah McQuitty

Graduates will see smaller student loan interest deductions in 2020.

As you go to file your 2020 tax return, much is the same as previous years, and yet a lot is different as well—you have items for the stimulus payments in 2020 and earlier this year in January (EIP1 and EIP2, respectively) and there are even new tax breaks (like the $300 above-the-line charitable donations deduction).

That said, some things may look a bit different in a way that seems off. If you’ve been paying off student loans since year before last, your student loan interest deduction for 2020 may look slim to none in comparison. What’s up with that? Don’t people need some extra tax relief for COVID-19 and paying off student loans?

Is there financial relief for student loan interest due to Coronavirus?

Absolutely—in most of 2020 and through to September 30, 2021, student loan payments are being deferred, and through 2025, employers have a lot of incentive to help employees pay off their loans.

The student loan interest deduction, on the other hand, is a long-standing tax break that wasn’t specifically designed for COVID-19 relief. It still helps you reduce your taxes owed, but because of the way the deduction is calculated, it may not be as big this year.

How does the student loan interest deduction work?

The student loan interest deduction reduces the amount of income you owe taxes on by the amount of interest you paid on loans. For example, if you paid $500 in interest over the course of the year, the deduction reduces your taxable income by $500.

The actual amount that reduces your tax bill is different for everyone, since it’s based on your tax bracket. If you’re single and fall in the 12% tax bracket, you’d be saving $60 (since that’s 12% of $500). If you’re married and fall in the 22% tax bracket, you’d save $100.

Okay, so why is my student loan interest deduction smaller in 2021?

Since the deduction is calculated based on how much loan interest you actually paid during the year, naturally it’s going to be smaller in a year where you weren’t required to make payments for the vast majority of the year.

Going to our example above, say you typically pay $500 of student loan interest in a year, but in 2020, you only paid about $125. Rolling with our tax brackets, the single person in the 12% bracket would only reduce taxes owed by $15, and the married couple at 22% would reduce it by $27.50.

Food for thought: If you can afford to, paying down any amount of your student loans before September 30 means a smaller cost in the long run. All your payment goes to principal right now since there’s no interest being charged, so once interest does kick back in, it’ll be less overall.

What’s better, a smaller student loan interest deduction, or deferred loan payments?

If you’re struggling financially because of the pandemic, deferred payments are better, for sure—after all, instead of our single person above paying $500 in interest and getting $60 back at tax time, they’ll pay only $125 in interest and still get back $15. That’s $110 paid overall instead of $440.

Even though your tax break looks a little puny, you’ve got more money in your pocket to help manage your finances.

Ready to file your tax return and claim the student loan interest deduction?

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