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For those Generation X'ers who complain about how life is unfair, you are absolutely CORRECT. Your parents in particular and boomers in general have had a much easier time paying for their college educations without taking out depressingly high amounts of student loans. Yes, it bytes! And, here's why. Why Didn't My Parents Have More Debt? A variety of factors are responsible for the escalating cost of attending college1 and the increased use of student loans (as well as credit cards!) to pay for it.2 More importantly, for our present interests, the federal tax reforms of the 1980s eliminated the deductibility of interest on student loans.3 This is significant since the cost of your college education (especially if you go to graduate school) is most likely your second largest expense--after buying a home. Believe it or not, your parents could pay for most of their college expenses in the 1960s and 1970s through a combination of federal grants (about three-fourths of federal college aid was in the form of outright grants then!) and summer earnings. Furthermore, student loans were subsidized and the vast majority featured low interest rates--3 to 5 percent. In 1977, median student debt was about $2,000 and even this modest amount was reduced through the high inflation of the late 1970s and early 1980s. Today, student loan levels are rising sharply as colleges and universities are responding to reductions in public funding by raising the cost of tuition. As shown in Table 1, tuition at American University in Washington, D.C. has risen more than seven-fold since 1975. Table 1 SPIRALING COST OF HIGHER EDUCATION:
Source: American University, Office of Financial Aid. In fact, just tuition in 2000-2001 is greater than the total cost of attending this university for four years in the late 1970s! As a result, the debt levels of students enrolled in four -year institutions has jumped dramatically. Between 1990 and 1996, the median debt of college graduates more than doubled--from about $7,000 to over $15,000. Today, "college inflation" continues to rapidly outpace the general rate of inflation. So, are financial conditions more difficult for students today? You betcha! The KEY issue, then, is how to maximize the few financial tax advantages available to you and your financially stretched parents. Hey, look, if we can ease the financial burden on your parents then maybe they will share some of this newfound money with YOU! Just trying to help those strained family relations. What's The Real Deal? So, you ask, how does it work? Well, beginning with tax year 1998, interest on student loans can be deducted from your taxable personal income. Sorry, the loan "principal" or amount that you borrowed (including miscellaneous processing fees) does not count toward your tax deduction. The only condition that disqualifies you is if you are still claimed as a dependent on your parents' tax return. And, to legally qualify for this deduction, you have to have been making payments on your students loans since 1998. Also, you can currently claim as a tax deduction only the interest on the first 60 months (that's 5 years for the mathematically challenged!) of your student loan repayment period. Don't whine, that is when you pay most of the interest anyway. Of course, there are no retroactive tax benefits for those who graduated in the early '90s. Yes, it bytes, but you will have to fight that battle with the U.S. Congress. Don't try to kill the messenger of bad news! The final qualifying condition is your taxable income. A maximum of $1,500 in student loan interest payments can be deducted from your 1999 Adjusted Gross Income (AGI, that is, after subtracti ng all of your tax deductions ) if it totals less than $40,000 for those filing single tax returns and $60,000 for married couples filing a joint tax return; these income "brackets" are slightly higher in 2000 and 2001. And, the total deduction for interest paid on student loans rises to $2000 in 2000 and $2,500 for tax year 2001. Thank the U.S. Congress (It takes and gives back!) since it was only $1000 for 1998. For those filing single returns, this tax deduction is phased out between $40,001 and $55,000 Adjusted Gross Income. This means that as your taxable income increases over $40,000 (AGI), then the tax deduction declines until it is zero at $55,000 (AGI) in 1999. Hence, if you make $55,000 (AGI) or more in 1999, you do not quality for this new tax deduction. Of course, if you're making over 55 grand right out of college, you're not really concerned over a few hundred dollars, right? For those filing joint returns, this tax deduction
is phased out between $60,001 and $75,000 Adjusted Gross Income
in 1999; these income "brackets" are slightly higher in
2000 and 2001. This means that if your combined taxable income exceeds
$60,000 (AGI) in 1999, then the tax deduction declines until it
is zero at $75,000 (AGI). For instance, if both spouses' income
is less than $30,000, then you qualify for the full deduction. Similarly,
if one spouse makes less than $60,000 and the other spouse does
not receive monetary wages/salary, then you qualify for the full
deduction. However, if the combined income of you and/or your spouse
totals $75,000 (AGI) or more, then you do not quality for this new
tax deduction. Note, you do not qualify if you are married but are
filing your tax return separately. How Do I Calculate My Income Tax Deduction? Okay, so now I've got your attention. FREE MONEY has that effect on most people! Anyway, all you need to do is check (1) the interest rate of your student loans [CHECK carefully, you may have more than one interest rate!] and (2) the total amount of your student loans. Remember, you can only claim as a federal tax deduction the first $1,500 in interest paid on your student loans in 1999 and $2,000 in 2000 rising to a maximum of $2,500 in 2001. The U.S. Congress is not that generous yet--at least until you start voting in larger political "blocks." So, let's do the math. How do we calculate your interest deduction? Let's suppose that after graduating in the spring
of 1999 that you had the national average of about $17,000 in student
loans. How much interest can you report as a deduction on your 1999
federal income tax return? For example, if they were low interest
loans, say 5% Perkins loans, then you could report a deduction of
only $850. If they were all 7% Stafford loans, then your total interest
payments of $1,190 are still less than the maximum. If they were
all private loans at 9%, then you paid $1,530 in interest-- almost
exactly the maximum deduction. A more serious challenge to your
basic math skills occurs when you have several loans with different
interest rates. For instance, suppose you had $7,000 in 5% Perkins
loans and $10,000 in 7% Stafford loans. Your interest payments would
be $350 (Perkins) and $700 (Stafford) or a total of $1,050--substantially
less than the maximum allowable deduction! Or suppose you had $4,000
in 5% Perkins, $10,000 in 7% Stafford, and $3,000 in 9% private
loans. Your total interest payments would be $200 (Perkins), $700
(Stafford), and $270 (private) or a total of $1,170. You get the
idea. Of course, if you are carrying a heavier burden, the calculations
are simple. For tax year 2000, the maximum student loan interest
deduction of $2,000 is reached for 5% Perkins loans at $40,000,
for 7% Stafford loans at $28,571 and for 9% loans at $22,222. For
tax year 2001, the maximum student loan interest deduction of $2,500
is reached for 5% Perkins loans at $50,000, for 7% Stafford loans
at $35,714 and for 9% loans at $27,778. See Table 2 for annual interest
payments on loans from $5,000 to $50,000. STUDENT LOAN INTEREST DEDUCTION:
So, is Uncle Sam going to give you $2,000 "cash back"--like the DISCOVER Card? No, not quite. These are income tax deductions that we are calculating. In the "real world," this means that your student loan interest payments can reduce your ta xable income--up to a maximum of $2,000 per year in 2000--during the first five years of your loan repayment schedule. Remember, this student loan interest deduction rises to $2,500 beginning in tax year 2001. For instance, if you earned $12,500 in taxable income in 2000 then this deduction would reduce your personal income for taxation purposes to $11,000. Similarly, if you earned $25,000 in taxable income in 2000 then it would reduce your personal income for taxation purposes to $23,500 and if you earned $37,500 in taxable income then it would reduce your personal income for taxation purposes to $36,000. This is a very important distinction. The federal taxation rate for 2000 is 15% if your taxable income (unmarried) is under $26,251 while it rises to 28% if your taxable income is between $26,251 and $63,550. See the taxable income levels (after subtracting tax deductions) of the five major tax rate brackets, both single and joint (married) filings, in 2000.4 Now, drum roll please, the bottom line. If your annual earnings place you in the 15 percent federal tax bracket, then reporting a maximum $2,000 student loan interest deduction yields a tax saving or potential refund of $300; if you pay $2,500 in student loan interest in 2001, your tax saving will be $375. If you are in the 28 percent federal tax bracket, this represents a tax saving of $560; if you pay $2,500 in student loan interest in 2001, your tax saving will be a hefty $700. Remember, you are eligible for this tax deduction each year that you report student loan interest payments AND you earn less than the maximum single or joint income thresholds up to the first 5 years of your loan repayment schedule. And, remember, Uncle Sam is getting more generous. Can you spell budget S.U.R.P.L.U.S.? The maximum student loan interest deduction was raised from $1000 in 1998, $1,500 in 1999, to $2,000 in 2000 and then $2,500 in 2001! If you are lucky, maybe Congress will continue to increase the maximum deduction ($3,500 would be nice), length of loan repayment (why not 10 years!), and maximum allowable incomes (an additional $20,000 in annual income is more reasonable) before you pay off your student loans. By the way, will that be in 10, 15, or 20 years? You may wish to visit the module that examines the issues concerning the refinancing of student loans. Lastly, before we move on to your parents, it is important to note that you can claim this deduction without filing an itemized tax return. As you will soon learn, this is quite a computational convenience. So, don't whine about what you can't deduct. Enjoy what you can and "Just Do It!" Now, what's airfare to Cancun? NEW EDUCATION-RELATED TAX DEDUCTIONS: For
Mom and Dad So, you're asking, HOW MUCH relief? Well, enough to make it worth your time. Here's how it works. Parents and other family members that pay for post-secondary educational expenses may qualify for the Hope Scholarship tax credit. This includes students enrolled in junior colleges, universities, and vocational training schools. The new tax credit permits you to claim up to $1,500 for tuition and other fees that were paid during each of the first two years of schooling per student--i.e., freshman and sophomore years. Beginning with the spring 1999 semester (January 1, 1999), you can claim 100% of the first $1000 and 50% of the second $1000 (or a maximum of $1500 per student) as long as they were enrolled in a degree granting program. There is, however, one important disqualifying condition. The Hope Scholarship tax credit can not be claimed for students with felony convictions relating to "controlled substances." That means if you get caught and it goes on your record, then your parents will pay too by losing this tax deduction. Do you hear that, slackers?!! Also, it is important to note that the credit is reduced by any financial scholarships that are received by the student. So, if you are in the 28% tax bracket and qualify for the maximum credit, this represents a tax saving of $420 for each of the two years. Otherwise, if you are in the 15% tax bracket, it represents a maximum tax saving of $225 per year. Lastly, the $1,500 maximum deduction will increase with the rate of inflation beginning with tax year 2002. So, you are not overwhelmed by this government largess. Johnny pays more on parking fines and Suzy on a "day-trip" trip to the mall. Well, there is more. A second new tax break is the Lifetime Learning credit. You can qualify for up to 20% of the first $5,000 in education-related expenses that were paid after June 30, 1998 for students in their junior or senior year of college as well as those high achievers enrolled in graduate school. Hence, the maximum tax credit is $1,000 per year or $200 for each $1000 in educational expenses up to a total of $5,000. Significantly, this tax credit is phased out for individuals with taxable earnings between $40,001 and $50,000 Adjusted Gross Income (AGI); rising slightly in 2000 and 2001. For those filing joint tax returns, the education credit is phased out for those families with combined incomes that range from $80,001 to $100,000 (AGI). If you are in the 28 percent tax bracket and qualify for the maximum credit, this represents an annual tax saving of $280. Otherwise, if you are in the 15% tax bracket, it represents a maximum tax saving of $150 per year. And, beginning with tax year 2002, the tax credit rises to 20% of a total of $10,000 in educational expenses. Just remind your folks that every little bit helps! There are no current limits on the number of students or years of supporting them in college so long as you can afford to pay for their expenses. In fact, Uncle Sam allows you to "double your pleasure" with these two new tax deductions if you are paying for two or more college students. Please note, however, that you can NOT claim both the Hope Scholarship and the Lifetime Learning tax credits in the same year for the same student. If you are paying for two different students (these credits apply to the financial support of other family members as well), you can claim a Hope Scholarship credit for one and a Lifetime Learning credit for the other. Please note that you are required to use Form 8863 but do not need to file an itemized tax return. So, a substantial return on a minimal investment of time. Of course, as you know, every little bit helps. And, what a surprise when it comes from the Feds!5 We suggest that you invest these unexpected savings in your IRA and maybe you can retire a year early! After all, you're not going to rely on junior to help pay for those unexpected expenses during your Golden Years, are you? Bibliography Anders, George. 1992. Merchants of Debt, KKR and the Mortgaging of American Business, New York: Basic Books. Braun, Denny. 1997. The Rich Get Richer, The Rise of Income Inequality in the United States and the World , Chicago: Nelson-Hall. Calleo, David P. 1992. The Bankrupting of America: How the Federal Budget is Impoverishing the Nation, New York: Basic Books. Citizens for Tax Justice, Its Working, But... The Resurgence of Business Investment & Corporate Income Taxes, (Washington, D.C.: Citizens for Tax Justice, 1989). See their web site at www. ctj.org. Friedman, Benjamin M. 1989. Day of Reckoning, The Consequences of American Economic Policy, New York: Vintage Press. Halberstam, David. 1994. The Fifties, New York, Ballantine Books. Harrison, Bennett and Bluestone, Barry. 1988. The Great U-Turn, Corporate Restructuring and the Polarizing of America, New York: Basic Books. Harvey, David. 1989. The Condition of Postmodernity, Cambridge: Basil Blackwell. Medoff, James and Andrew Harless. 1997. The Indebted Society, Anatomy of an Ongoing Disaster, New York: Little, Brown and Company. Phillips, Kevin. 1993. Boiling Point: Democrats, Republicans, and the Decline of Middle Class Prosperity, New York: Random House. Pollin, Robert. 1990. Deeper in Debt, The Changing Financial Conditions of U.S. Households, Washington, D.C.: Economic Policy Institute. Ryscavage, Paul and Peter He nle. 1990. “Earnings Inequality Accelerates in the 1980s,” Monthly Labor Review, (December), pp. 3-16.
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