Student loan interest became deductible beginning with tax year 1998. The interest you pay is an "above the line" adjustment, which means that it is subtracted from your income before the deductions (standard or itemized) or exemptions, so it lowers your adjusted gross income.

As with most adjustments, the student loan interest deduction has some restrictions:

• Currently, the most you can deduct is $2,500 in interest. The deduction starts phasing out when your Modified Adjusted Income reaches $55,000 ($110,000 for married filing jointly).
  
  

  Example 1: John, who is single, made student loan payments the entire year. His income was $57,000 and his total interest payment was $450. His adjustment is computed as follows:

  Total interest paid	$450.00
  Maximum of $2,500	$2500.00
  Lesser of interest paid or amount allowed (lesser of items 1 and 2)	$450.00
  Adjusted Gross Income	$57,000.00
  Modified Adjusted Gross Income (MAGI) (See instructions for Form 1040 on how to compute)	$57,000.00
  Subtract MAGI from base amount for filing status	$7,000.00
  Divide $7000 by $15,000 and round the result to three decimal places	.466
  Multiply the resulting decimal amount by the amount on line 3. ($450 x .466)	$210.00
  Allowable deduction: ($450 - 210)	$240.00

  
  

  Example 2: Jackie made $28,500 and had interest payments of $15.00 per month for a total of $180. Because her income is under the income phase-out and the interest is below the maximum, she can take the entire $180 as an adjustment to income on line 25 of the Form 1040, or line 18 of Form 1040A.

• You can deduct interest that you are required to pay AND interest payments that you make voluntarily. This is a change from 2001 law.
  
  

  Example: Suzie graduated in May and landed a great job. She is required to start making payments on her student loans beginning November 1, but because she has the money, she begins making payments in June. Fortunately, Suzie can now deduct the interest for November and December.

• You cannot take the adjustment if you are claimed as a dependent by another taxpayer.
  
  

  Example: Tom, age 22, graduated in May. His parents paid his room, board, and tuition in January and continued to subsidize his expenses throughout the year, ultimately providing for over half of his support. Tom began making student loan payments in November, as required. His parents are eligible to claim him as a dependent, and if they do, he cannot take the adjustment for the loan interest he paid.

• Your filing status can not be married filing separately.
  
  
• You must use the loan to pay for higher education expenses for yourself, your spouse, or your dependent (if that person was a dependent at the time you got the loan).

Take advantage of this deduction! If you qualify, the student loan adjustment can result in considerable tax savings.