PAID INTEREST ELIGIBLE FOR TAX DEDUCTION

There are a number of common tax debts that accumulate interest. Paying interest is a certainty that most of us deal with, whether we like it or not. Be it your student loans or home mortgage. The longer interest accrues, the more expensive repayment becomes, and when you’re dealing with tens or hundreds of thousands of dollars of debt, interest can quickly add up. Even if you’re lucky enough to have low interest rates, it’s only likely to seek ways to reduce your overall outgoing costs. Believe it or not, tax season may be the ultimate break to catch when it comes to paying interest. Now to the golden question: is interest on debt tax-deductible? The answer is sometimes. Using this guide, we’ll see the types of interest that are tax-deductible as well as the advantages of deducting interest.

What Type of Interest is Eligible for Deduction?

Before the Tax Reform Act of 1986 was imposed, taxpayers were permitted to deduct interest on an extensive array of tax debts, including credit card debt and personal loans. This mid-1980s tax reform law effectively ousted deductions for personal interest, thereby making credit card, personal loan, and medical loan interest excluded from deduction on tax returns. Though the tax laws concerning interest haven’t changed much over the course of the past few decades, there are a number of tax-deductible interest types that are designed to lessen your annual taxable income. Interest paid on student loans, mortgages, business loans, and margin tax debts are among the most common. Let’s take a more in-depth look at how each of these types of interest can affect your tax filing and what forms you’ll need to deduct them.

Student Loan Interest

As of 2020, there are an estimated 44.8 million borrowers with student loan debt, most of which will likely be able to deduct accumulated interest on their tax returns. This number continues to amass with every passing year, and to accommodate the ever-rising number of university students burdened with weighty tax debts, the IRS offers a student loan interest deduction. The student loan interest deduction allows you to deduct a maximum of $2,500 from your taxable income provided that your modified gross income (MAGI) was less than $70,000 in the past tax year. The loan(s) in question must be eligible under IRS standards to be eligible for tax-destructibility. Qualified loans must be taken out by you, the taxpayer, a spouse, or a dependent. Qualified loans also must have been taken out for educational purposes during a period in which you, your spouse, or dependent is enrolled at least part-time in a degree program. In addition, the loan in question must have been used to pay for tuition, textbooks, coursework supplies, fees, or other relevant expenses. Qualification for the student loan interest deduction is also dependent upon the educational institution’s qualification. Under IRS authorization, eligible institutions include all public, non-profit, and privately-owned-for-profit post-secondary institutions that take part in student aid policies managed by the US Department of Education. If you paid more than $600 in interest in 2019, you will automatically receive Form 1098-E in the mail or via email. If you paid less than $600, you can still deduct paid interest. You will need to contact your student loan provider and ask for a physical or digital copy of Form 1098-E.

Business Loan Interest

Growing and managing a business requires a number of expenses that are often funded by business loans. From accommodating lines of credit to property mortgages, there are a number of uses for everyday business loans. Like any other loan, business loans accumulate interest over time. Fortunately, this interest is tax-deductible under certain conditions. These conditions include a true lender-debtor relationship, legal liability for the debt, and an agreement from both lender and debtor for the debt to be repaid. The type of loan you have will also affect how much of your interest is tax-deductible. The following are among the most common types of business loans that may be qualified for small business deductions: ü Personal Loans (for mixed purposes) ü Business Lines of Credit ü Term Loans ü Business Purchase Loans ü Short-Term Loans To calculate the amount of business interest you can deduct for the tax year, use IRS Form 8990. With these narrowed down numbers, sole proprietors and single-member LLCs should claim deductible interest in the “Expenses” section of Schedule C on Line 16. For partnerships and multiple-member LLCs, these expenses should be recorded in the “Other Deductions” section of Form-1065. Note that you will be required to provide evidence of the business debt in the event that you’re audited by the IRS, should you claim a deduction for interest paid. Also bear in mind that businesses with average gross receipts of $25 million or more can only deduct up to 30% of interest on their business debts before taxes, depreciation, and interest.

Margin Debt Interest

If you borrow money from a lender for the purpose of investment, you may be able to claim a deduction for interest on margin debt incurred. The value of the deduction is capped at the net taxable investment income you’re able to claim during the tax year, in the event that you do not have any net taxable investment income to claim, you can carry over the remaining interest expense. This gives you the ability to potentially deduct the interest from net taxable investment income the following tax-filing year. The deduction for margin debt interest is calculated using IRS Form 4952 but can also be done with some quick math. To calculate your deductible margin interest, take your gross income and subtract all qualified deductions, net gains, and other investment expenses. The remaining number is your net investment income. For example, if you have an investment income of $1,000 and interest expenses of $500, you can deduct all $500 on your tax return.

Home Mortgage Interest

If you borrow money to afford a home, you may be eligible for a mortgage interest deduction. Per IRS regulations, you can take up to $750,000 in an interest deduction if you purchased your home after Dec. 15, 2017. This also applies to mortgages up to $1 million purchased prior to Dec. 15, 2017. You can also take advantage of the home mortgage interest deduction if you pay home equity loan debt, but only under the condition that you use the profits from the home equity loan to build, buy, or improve the home that secures the home equity loan. To claim the home mortgage interest deduction, you’ll need IRS Form 1098, or your mortgage interest statement from your mortgage lender, well-kept records documenting the details of your home and mortgage, and Schedule A to claim your itemized deductions What is the Advantage of Deducting Paid Interest? The ultimate advantage of deducting paid interest is gaining the ability to reduce your taxable income. Just like all other types of tax deduction, taking advantage of interest deductions could let you move down into a lower tax bracket. This would allow you to be taxed at a lower federal rate, effectively putting more money back into your pockets.