Monthly Archives: February 2012

Can I deduct the interest I pay on student loans that are in my parents’ names?

For most college graduates, paying back student loans is part of growing-up.  A portion of those payments is, of course, payment of interest.  While most personal interest is not deductible for income tax purposes, the Internal Revenue Code (the “Tax Code” or “Code”) provides a special exception for student loan interest.  The Code, in Section 221(a), provides:

Allowance of deduction.  In the case of an individual, there shall be allowed as a deduction for the taxable year an amount equal to the interest paid by the taxpayer during the taxable year on any qualified education loan.

The Code limits this potential deduction in several ways, and this post discusses one such limitation.  Many parents help pay for their children’s college by obtaining Parent PLUS Loans, which are government loans that recognize parents (and some others) are generally in a better credit-position to borrow than their children.

In addition to Parent PLUS Loans, students often take out loans in their own name to cover the remaining expenses.  After graduating, students quite often pay back their loans and the Parent PLUS Loans as all of the debt went to pay for their education.  As long as the student meets the Tax Code’s conditions, he or she can deduct the student loan interest paid on loans in their own name up to a certain amount.  But can they deduct the interest they paid on the Parent PLUS Loans?

The answer is no – even when the student is the one actually making the loan payments from they own funds.  The reason comes down to the Code’s definition of a “qualified education loan,” which reads as follows:

. . . any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses . . . . 42 U.S.C. § 221(d)(1) (emphasis added).

With a Parent PLUS Loan, only parents are legally obligated to pay the loan and the loan’s interest.  The student takes on no legal obligation, and therefore, no indebtedness where his or her parent utilizes a Parent PLUS Loan.  IRS publications agree this is the case.  Click the following link for the student loan interest portion of IRS Publication 970 with Joshua Werbeck’s notes.

Furthermore, students cannot simply execute an agreement with their parents obligating them to pay the interest.  The Tax Code’s definition of qualified education loan exempts indebtedness to related persons and some business entities.  See 42 U.S.C. § 221(d)(1) (“flush language” at the bottom of the subsection).

If you’d like, you can read the law yourself.  Here is a link to Section 221(a) of the US Tax Code covering the student loan interest deduction with Joshua Werbeck’s notes.

But what happens to the potential deduction if the person actually paying the loan is not entitled to utilize the deduction.  The person legally obligated to pay the qualified education loan, the parents in my example above, are entitled to the deduction even if they never actually made a loan payment.

Some payment options with the IRS just got a little kinder and gentler!

When you owe the IRS money and you can’t pay everything right away,  typically there are three  options:  (1) convince the IRS you can not currently pay anything and have your account marked as “currently not collectible;” (2) set up a payment arrangement; or (3) seek to settle through the offer in compromise program.  Each option has its pros and cons.  The IRS recently announced some helpful changes if you want to pursue the second option of setting up a payment plan.

 Rules for IRS payment plans have always been classified based on how much is owed.  These rules generally address the length of time that can be given for payment, the amount of financial disclosure required before a monthly payment amount will be accepted, and whether a tax lien will be filed.  The significant thresholds of balances owed are $10,000, $25,000, $50,000 and over $100,000.   As you would expect, the more you owe the more involved the rules become.  Therefore, as a threshold consideration,  before approaching the IRS about a payment plan, consider whether a partial payment can be made to move you down a tier or more in the escalating set of rules.   

 The recent changes relate to the “streamline installment agreements” for taxpayers owing less than $25,000 and those owing between $25,000 and $50,000.  In each instance, taxpayers may now be given up to six years to pay an obligation (increased from five years).  Taxpayers owing between $25,000 and $50,000 now need to make monthly payments by direct debit from a bank account.  Also, at this higher level some financial disclosure will be requested but the sole purpose for gathering this information is to ensure that the payments can be maintained for the life of the plan, not to glean the highest monthly payment that can be made.  Generally a tax lien will not be filed at either of these levels under the streamline rules.

 If a payment plan is the best option to resolve a tax debt, all of these changes should make setting up a payment plan easier.

Is the IRS Going Out of Business?

Very recently the IRS Taxpayer Advocate warned Congress that the IRS’s workload continues to increase while its funding is decreasing.  The Taxpayer Advocate is concerned that under these circumstances, the IRS is not able to do the job it is tasked with doing.  While some may smile when hearing such news and think–  “Good, the less IRS the better!”– be careful what you ask for. 

As the funding for IRS operations is reduced, services that we have come to expect from the IRS are vanishing as well.  Reaching a local IRS agent by telephone is fast becoming a thing of the past.  More and more often, matters are being assigned to 800-number call centers where you can be on hold for 30 minutes or more before reaching a live person.  If you need to call back with more information, you endure the same wait and end up with a different person.

Delays are part of the process when dealing with a tax problem but now those delays seem longer than ever.  With outstanding obligations accruing interest and sometimes penalties, delay can be costly.  The IRS always encourages voluntary payments while an issue is being reviewed and given these delays, sometimes that can make  sense.

As the IRS faces the same economic challenges of any other business, having an experienced advocate that knows where to go, knows how to streamline the process, and knows how to manage the ever changing bureaucratic landscape is important.