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will be complete at $l35,000 of modified adjusted gross income. The income
levels for the phaseout were set for 2005 and they are subject to being
adjusted to reflect changes in the cost of living. For most taxpayers, their
modified adjusted gross income will be simply their adjusted gross income
plus their student loan interest deductions that they took. The phaseout is
calculated by dividing the amount by which the taxpayer s adjusted gross
income exceeds the party s income level at which the phaseout begins by the
full amount of income in the phaseout range and multiplying that by the
eligible student loan interest incurred for the year.
EXAMPLE: Joe paid student loan interest of $1,000 for the year. He and his
wife filed a joint return that showed modified adjusted gross
income of $120,000. Assuming that the income limits for
phaseout of the student loan interest deduction that were in effect
were the same as were in effect in 2005, the excluded amount of
Joe s student loan interest deduction would be calculated as
follows:
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124 Tax Power for Individuals
$15,000 (amount of income in excess of maximum without
phase out) ÷ $30,000 (full phaseout range ($135,000 
$105,000)) X $l,000 (student loan interest payment for the year)
= $500
The excluded amount, which is $500 in this example, is then
deducted from the total student loan interest payment of $1,000
to leave a deductible amount of $500. The phaseout is done on a
pro rata basis, as is shown since the $15,000 by which Joe s modi-
fied adjusted gross income exceeded the highest level at which no
phase out would occur ($105,000 in his case) is 50% of the
$30,000 bracket (the difference between $105,000 and $135,000)
over which the phaseout was imposed.
In calculating the allowable student loan interest deduction, taxpayers who
have sufficiently high modified adjusted gross income that they must phase
out part of their allowable deductions must remember that regardless of how
much student loan interest they have actually paid, they must take into
consideration the fact that the maximum amount of student loan interest
upon which taxpayers can base their deductions is $2,500. Although Congress
may always alter the amount at any time, there are no provisions in the law
for changes in the amount to reflect changes in the cost of living and the limit
has remained the same for a number of years.
EXAMPLE: Tal made student loan interest payments of $3,000 last year. The
filing status on his tax return was single and he had modified
adjusted gross income of $59,000. Assuming that the same
income limits for phaseout of the student loan interest deduction
are in effect as were in effect in 2005, the reduction in his student
loan interest deduction will be calculated as follows:
($9,000 ÷ $15,000) X $2,500 = $1,500
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Nonbusiness Deductions for Adjusted Gr oss Income 1 25
This will leave him with an allowable student loan interest deduc-
tion of $1,000, which is the remainder when the $1,500 reduction
in his student loan interest deduction is subtracted from the
maximum allowable student loan interest deduction of $2,500.
Note that rather than using his actual $3,000 interest payments
for the year in calculating his allowable student loan interest
deduction, Tal will have to net the reduction in his eligible
student loan interest deduction against the $2,500 maximum and
he will also use the $2,500 maximum in calculating the reduction.
In addition to actual interest on student loans, taxpayers may also take a
student loan interest deduction for payment of a loan origination fee as
long as the fee was not paid for property or services that were provided to
the taxpayer by the lender. However, loan origination fees that are eligible
for deduction as student loan interest must generally be allocated over the
life of the loan and deducted accordingly. If a taxpayer pays interest on a
student loan before he or she is required to do so, such as when a party
starts making payments right after graduation before the mandatory
commencement date for repayment of the loan, it will not affect the
deductibility of the interest payments.
DOMESTIC PRODUCTION ACTIVITIES DEDUCTION
Individuals involved in certain production activities in the U.S., which are
referred to as domestic production activities, will be allowed to take a deduction
for adjusted gross income in an amount equal to 3% of the lesser of their
incomes from qualified production activities or their adjusted gross incomes
provided that they meet certain requirements. The basic requirements for
eligibility for the domestic production activities deduction is that the
taxpayer must have qualified production activities income, must have posi-
tive adjusted gross income, and must have paid Form W-2 wages to
employees. Taxpayers who own interests in S corporations and partnerships
or who are beneficiaries of trusts or estates can take the deduction on the
basis of qualifying activities of those entities if the entities meet the criteria
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126 Tax Power for Individuals
for the deduction and allocate taxpayers shares of qualified production
activities income, taxable income, and wages paid to employees to the
owners and beneficiaries, which they can then use to qualify themselves for
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