Deducting Student Loan Interest

If you are a Dental Specialist who becomes licensed and you work as a dentist prior to going to a specialty program, it can mean the difference between being able to deduct interest on your student debt or not.

Student loan interest is deductible for any taxpayer but there are significant limitations. According to the Annual Resident Survey conducted by Bentson, Clark & Copple (See article in the October issue of TPO), orthodontic residents expect to have amassed student debt of between $100,000 and $400,000 upon completion of their educations. That is certainly consistent with the amounts we see among our clients.

Some orthodontists may have the ability to deduct interest incurred during their residencies as a business expense if certain steps are taken and certain conditions are met.

For starters, let’s look at the typical taxpayer’s ability to deduct student loan interest. The maximum deduction allowed is $2,500. If you have a loan of $100,000 at 7.5% you will pay $7,500 in interest – three times the deduction allowed.

Now for the bad news: If you earn $75,000 as a single taxpayer or $150,000 as a married taxpayer filing joint tax returns, your $2,500 deduction phases out meaning, you get no deduction at all. (“Phase-out” is a term you will hear a lot when asking your Dental CPA whether something is deductible).

Graduates from dental school or an orthodontic residency may qualify for the $2,500 student loan deduction in their first year working, especially if they finish their programs in the spring, only work half a year and earn below the income phase-out amounts. Often, however, student loans are in deferment for six months or more with no interest paid in that first year so there is nothing to deduct.

For dentists going into the workforce after dental school, it is not likely one would ever qualify for a student loan deduction. For orthodontists and other specialists, it is possible to work around this problem.

Here’s how according to a “Private Letter Ruling” given by the IRS in 1974: “Expenditures incurred in taking postgraduate studies in orthodontics by a dentist engaged in general practice who returned to dental school on a full-time basis while continuing his practice on a part-time basis and, after completing his training, limited his practice to orthodontic patients, are deductible under section 162 of the Internal Revenue Code, “Trade or Business Expenses.”

Specifically, “expenditures made by a taxpayer for his education may be deductible as ordinary and necessary business expenses even though the education may lead to a degree if the education maintains or improves skills required by the taxpayer in his trade or business.”

Simply stated, the education expenses are not deductible if they lead to the taxpayer being qualified in a new trade or business. The ruling concludes, “in this case the expenditures by the dentist for postgraduate studies in orthodontics were not incurred in connection with qualifying him for a new trade or business but were in connection with improving his skills as a dentist. Accordingly, such expenditures are deductible as ordinary and necessary expenditures under section 162 of the Code.”

Let’s break this down into plain English:

1) Deductible education expenditures include tuition, books, supplies, lab fees and “similar items.” If you have to borrow money to pay for these expenditures, the interest on that debt is also deductible.

2) The most critical statement in the private letter ruling (PLR) is that the dentist continued his practice part-time while in the orthodontic residency. That is why I said, “some orthodontists may have the ability to deduct their student loan interest…”

3) If dental school graduates go immediately to specialty school, the IRS considers them to still be dental students pursuing a trade or business, not someone improving their skills as a dentist.       Thus, no deduction for student loan interest.

4) How does a dental student get around this? Upon graduation from dental school, they must take the boards and get licensed. And, they must work as a dentist before going off to a residency.

  • This is not always easy given the timing involved and that many of the 60+ orthodontic residency programs in the United States do not permit their residents to work.
  • Perhaps any restrictions on work refer to permanent employment and not an occasional day worked here or there, or, working during any breaks in the academic year. Or, maybe permission can be obtained to work on a limited basis under some conditions or on a case by case basis.
  • If work is permitted, that work simply needs to require a dental license which means it can include doing hygiene that can be arranged through a temp agency.
  • What if you become licensed in California and your residency is somewhere on the east coast? You will need to be licensed to practice near your residence or travel home a lot. I have a client who did his residency at NYU and traveled home to San Francisco during breaks to visit his family and work.
  • While most states will recognize licenses issued in other jurisdictions, almost all of them have requirements that you be licensed in good standing for 2 – 5 years beforehand, so you may have to take another set of board exams.

What is the tax benefit to an orthodontist who is able to deduct interest on debt incurred during their residency as a business expense? On a loan of $100,000 at 6% interest for 20 years, the total interest paid would be $74,000. Assuming a 40% tax bracket, the tax savings from that interest deduction would be almost $30,000. For a loan of $300,000, total interest paid in 20 years would be $223,000 and the tax savings would be just over $89,000 using the same 40% tax rate.

The tax savings might not seem like that much money each year but if you consider options for the use of those dollars (Emergency Fund, IRA contribution, College Savings, Life Insurance, etc.), the deduction becomes more compelling and the up-front planning and extra effort to achieve this result may not seem so insurmountable.

At a minimum, it is worth discussing the idea with your Dental CPA/Financial Planner to determine whether or not the cost in time, heartache and money outweigh the benefit of being able to enjoy a tax deduction for the student loan interest paid on debt incurred during your residency.

A Final Thought…

Keep careful track of all your student loans (undergrad, dental school, and residency). And, unless a reduction in interest rates or modification of terms makes it extremely compelling, try to avoid consolidating your loans so the interest paid may be allocated to the proper phase of your education and deducted where appropriate.