During the latter part of the twentieth century, two factors greatly impacted the economics of education -- the cost of a college education skyrocketed and the availability of scholarships and grants decreased substantially.  Because of these changes, earning a degree without getting into debt has become increasingly more difficult. If you're currently paying student loans, don't forget that the interest on those loans is tax deductible.

$2,500 per year

Each year, up to $2,500 of student loan interest can be deducted.  What does that mean to you?  If you're in the 28 percent tax bracket, you'll save as much as $700 in taxes annually by deducting your student loan interest.

What Qualifies as a Student Loan?

To be deductible, the loan must have been issued to you or your dependent and used to pay for qualified higher education expenses such as tuition, fees, room and board, books, equipment, and other necessary expenses.  Each year, during January, you should receive a Form 1098-E from the loan processor reflecting the total student loan interest you paid during the previous year.

How to Deduct Student Loan Interest

Claiming the student loan interest is easy.  Simply report the amount of interest you're allowed to deduct as an "adjustment to income" on your Form 1040A or Form 1040.  Make sure not to submit the short form (1040EZ), since there's nowhere on that form to claim student loan interest. 

What if you don't have enough deductions to "itemize your deductions"?  No problem.  The rules allow you to claim your student loan interest even if you don't "itemize".

Your Deduction Might Be Limited

Even if the amount of student loan interest paid during the year exceeds the maximum deduction of $2,500 this year, your deduction might be partially or completely disallowed if you earn too much money.  For 2005, your student loan interest deduction will be partially disallowed if your adjusted gross income (AGI) exceeds $50,000 ($105,000 if you're married) and completely disallowed if your AGI exceeds $65,000 ($135,000 if you're married).  Remember, AGI is equal to your income before deductions.

Maximize Your Deduction

Plan ahead.  By taking advantage of pre-tax opportunities, such as contributing to your employer's 401(k) plan or an I.R.A., you will decrease your AGI and, therefore, might increase your allowable student loan interest deduction.  You should also take a look at your situation at the end of the year and determine whether you will benefit by delaying your December loan payments into the following year or accelerating your January loan payments into the preceding year.

To find out more about deducting student loan interest, read through IRS Publication 970, Tax Benefits for Higher Education, available at www.irs.gov, or check out the information available at FinancialAid.com.