Student loans aren’t going away anytime soon, so what’s next?

Earlier this week, my daughter committed to college for neuroscience. It was not an easy discussion. She’s a smart kid – good grades and test scores, an athlete in two sports, president of the school newspaper, honor societies, all of it. She was thrilled to get into one of the best schools in the country. And we refused it.

The main reason ? Money. Tuition and fees, including room and board, were over $80,000 per year.

Assuming there is no increase, that brings the cost of his undergraduate education to over $300,000. I have three children. You can do the math.

Typically, when I mention the cost of college, I’m hit with a barrage of “What about scholarships?” And “Why not just go somewhere more affordable?” So let me answer these questions. Many graduate schools do not award merit scholarships, only need-based scholarships. And others, like two that my daughter was drafted for as an athlete, are Division III, meaning there’s no money for sports. Despite these limitations, my daughter has received scholarship offers worth hundreds of thousands of dollars, which still leaves out-of-pocket expenses of over $50,000 per year for some schools.

The cost of college

As for the “more affordable” options? According to US News, the average tuition cost to attend a private college is $38,185 per year – not including room and board, while the average public school costs $10,388 – again, not including room and meals.

And geography matters — tuition and fees for UNC-Chapel Hill are about $9,000 a year for in-state students, just under half the cost to attend PSU in as a state student in Pennsylvania.

I say all of this for context. There’s been a lot of talk lately about student loans, and I think some of those cost details have disappeared.

Student loans

I am determined that my children will not take out student loans. One of the reasons? I’m still paying off my own student loans.

I realize that some find this shameful; I’m not bothered by reviews.

I am a first generation college graduate. I started university at 16 with no money; I borrowed because I had no other options. And when I got into law school, despite having three jobs, I needed loans to pay tuition.

Today, I am one of 79 million adults who have taken out a federal student loan to pay for college. About 42 million of us are still repaying those loans, of which only 7.5 million are less than 25 years old.

I have always considered my studies as an investment and I am well aware that I could not have gone to college and law school without my loans, even with grants and scholarships.

But when I look at the numbers, I wonder how we got here.

History of paying for education

For years, higher education was largely a goal reserved for the wealthy. By the mid-1940s, more than half of the United States had no more than eighth grade, and only 6% of men and 4% of women had completed four years of college. The GI Bill would begin to change that, sending nearly 8 million World War II veterans to college. But outside of the GI Bill, there were few ways for low- to middle-income families to pay for school.

When the Soviets launched Sputnik into orbit in the 1950s, it sent the United States into a competitive frenzy. To help send more students to college, the first federal student loans were created under the National Defense Education Act in 1958. a quarter of a century before the Department of Education (DOE) was created in 1867 Today, the DOE has the third-largest discretionary departmental budget, behind only the Department of Defense and the Department of Health and Human Services. As part of its functions, the DOE provides $150 billion in new and consolidated loans each year.

As you can imagine, these loans generate a lot of interest. People can be quick to point out that it’s tax deductible. But the history of the deduction and its current status are worth a look.

Student loan interest history

Interest, in all its forms, has been deductible under our income tax system since 1894. But when the income tax was declared unconstitutional, Congress got back to work, creating a new federal income tax system that was enacted in 1913.

The interest deduction survived the renovation, and on the 1913 tax return, “all interest paid in the year on the taxpayer’s personal debt” could be claimed as a deduction.

This changed in 1986. As part of the Tax Reform Act of 1986, several deductions were eliminated. Specifically, Section 511(b) of the 1986 TRA repealed the deduction for personal interest, including interest on student loans.

The law changed again in 1997, when a student loan interest deduction was explicitly provided, much like the mortgage interest deduction. Section 202 of the Taxpayer Relief Act of 1997 provided that interest paid for student loans would be deductible. Interest paid before 1998 remained non-tax deductible.

In a twist, taxpayers with student loans could deduct interest paid on those loans for themselves, their spouses, or their dependents “whether or not the taxpayer itemizes other deductions.” Today, we sometimes call it an “over the line” deduction or an “income adjustment.” For years, it was on the first page of your Form 1040, but for the 2021 tax year, you’ll find it on Part II of Schedule 1, thanks to efforts to simplify tax forms.

Under the old law, the deduction was only available for interest payments made during the first five years of the loan. This changed in 2001 as part of the Economic Growth and Reconciliation of Tax Relief Act 2001 – the five-year rule was removed, albeit temporarily. Today, there is no five-year rule.

In 1998, the maximum amount of student loan interest that could be deducted was $1,000. This amount rose to $1,500 in 1999, $2,000 in 2000 and $2,500 in 2001. The needle has not moved since.

Student Loan Interest Deduction Today

In 2022, the interest deduction on your student loan is capped at $2,500. If it had been indexed for inflation, the deduction would have been worth over $4,000; if increased at the same rate as tuition, the deduction would be worth nearly $7,000.

What if you are married? This $2,500 cap is per tax return, not per taxpayer. This means that married taxpayers are limited to $2,500 even if both taxpayers have loans. And you can’t get around that – you can’t claim the deduction if your status is married and you’re filing separately.

The deduction is also subject to income phase-outs, which means that as your income increases, your maximum deduction decreases. These phase-outs are indexed, unlike the amount of the deduction, which means that they are adjusted each year according to the cost of living.

For 2022, the deduction is subject to phase-out when the modified adjusted gross income (AGI) is $70,000 for single taxpayers and $145,000 for married taxpayers filing jointly. The deduction is completely eliminated for single taxpayers with an AGI of $85,000 or more and married taxpayers filing a joint return with an AGI of $175,000 or more.

Interestingly, this means that President Joe Biden’s proposal to cancel student debt for those earning less than $125,000 would leave those with student debt unable to claim the tax deduction.

Who benefits?

So how good is the student loan deduction?

For the 2019 tax year, approximately 12,719,000 taxpayers claimed the student loan deduction, totaling $14.415 billion, or an average of $1,133 per return.

By comparison, when investing in another type of asset, roughly the same number of taxpayers – 13,656,000 – claimed $185 billion in mortgage interest, or an average of $13,547. This is despite the doubling of the standard deduction.

And now?

Usually I try to deliver takeout, and this week I’m not sure I made it.

You see, I’m not a tax policy expert, and I’m not a politician. I am a tax lawyer. And I’m also a mom. And I don’t have the answers.

That said, I don’t believe that the current rate of college costs is sustainable for families like mine. So far, proposals to fix it seem to be failing. We cannot continue to simply encourage students to borrow more to pay increased costs. And if we cancel some loans but keep the system in place, nothing will change. A bolder and more considered solution is needed.

For more information on the student loan interest deduction, see IRS Publication 970.

This is a regular column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest tax news, tax law and tax policy. Look for Erb’s column each week in Bloomberg Tax and follow her on Twitter at @taxgirl.

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