A Simple IRS Rule Could Cost College Grads $7 Billion In Lost Tax Credits

UMass Lowell college graduate

It’s been a few weeks since lawmakers let the interest rates on subsidized Stafford student loans double to 6.8%, reportedly adding an additional $1,000 to borrowers’ burden after graduation.

Beyond the initial blow of extra interest payments, graduates could also lose a considerable amount of cash on tax credits, according to a new analysis by NerdWallet Taxes.

Whenever students pay interest on a federal student loans, they are able to claim those interest payments as a deduction on their taxes.

The IRS caps interest rate deductions at $2,500 per year, which means graduates may wind up paying more in interest than they’re able to deduct. For example: if Bobby pays $3,500 in interest on student loans today, he will only able to claim $2,500 as a credit on his taxes.

It gets worse for high-earning graduates. Once grads start earning $75,000 or more, they no longer qualify for the interest rate deduction at all.

Over a 10 year repayment period, the top 5% of high earning graduates could lose up to $4,000 in possible tax credits, according to Nerdwallet. When you also factor in the cost of the doubled interest rate, that would add another $4,800 to their load, totaling $8,800 over a decade.

Now, if the IRS decided to expand its interest rate deduction rule by an extra $1,000 to compensate for higher interest rates, Nerdwallet estimates graduates could save up to $7 billion over 10 years in taxes alone.

Unfortunately, that outcome isn’t looking likely. 

“Even though student loan rates have doubled, the $2,500 limit is not set to increase anytime soon, as the IRS set the limit for years 2001 and beyond back in 1986 in the Internal Revenue Code,” Nerdwallet’s Dana Lime notes.

As for raising the cap on interest deductions, Lime points to a bill introduced by House Rep. Charles Rangel, who suggested raising the cap from $2,500 to $5,000. 

According to Govtrack.us, a government transparency monitor, the bill has “only a 1% chance of making it through committee and is unlikely to be passed in time to help students.” 

So, what’s a cash-strapped college grad to do?

1. Minimize loans. If you’re still in school, you’ve got time to minimize your student loan damage. That means steering clear of private loans (and their sky-high interest rates) altogether, and researching tuition rates rigorously before enrolling. You can offset costs with scholarships and grants whenever possible, which may involve a lot of pre-planning. 

2. Consider crowdfunding. For a cash-strapped college graduate who has exhausted every repayment option possible and is still struggling, the hot new trend in fundraising is online crowdfunding. This can be as simple as launching a page on GoFundMe.com and passing it around to your friends and family to contribute online. If you’re on the entrepreneurial track and have a solid business plan, you could stand a chance at getting your loans paid off with investor dollars via sites like Upstart.com. 

3.  Research other tax credits. The Lifetime Learning credit or American Opportunity credit are both viable options.

Also, see our guide to paying down student loans when you’re broke >>

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