Whether you’re a recent high school graduate going to college for the first time or a returning student, paying for college can be a daunting financial task. The following are some tips about education tax benefits that can help offset some college costs for students and parents.
American Opportunity Credit—In many cases, this credit offers greater tax savings than other existing education tax breaks. Here are some key features of the credit:
- Tuition, related fees, books, and other required course materials generally qualify.
- The credit is equal to 100 percent of the first $2,000 spent and 25 percent of the next $2,000, which means that the full $2,500 credit may be available to a taxpayer who pays $4,000 or more in qualified expenses for an eligible student.
- You may qualify for this credit even if you have previously taken the Hope or Lifetime Learning credit.
- The full credit is available for taxpayers whose modified adjusted gross income (MAGI) is $80,000 or less (for married couples filing a joint return, the limit is $160,000). The credit is phased out for taxpayers with incomes above these levels. These income limits are higher than those under the Lifetime Learning credit.
- Forty percent of the American Opportunity Credit is refundable, which means that even people who owe no tax can receive an annual payment of up to $1,000 for each eligible student. Other existing education-related credits and deductions do not provide a benefit to people who owe no tax. The refundable portion of the credit is not available to any student whose investment income is taxed at the parents’ rate, which is commonly referred to as the kiddie tax.
Although most taxpayers who pay for post-secondary education qualify for the American Opportunity Credit, some do not. Limitations include a married person filing a separate return, regardless of income; joint filers whose MAGI is $180,000 or more; and, finally, single taxpayers, heads of household, and certain widows and widowers whose MAGI is $90,000 or more.
Some post-secondary education expenses do not qualify for the American Opportunity Credit. These include the expenses of a student who, as of the beginning of the tax year, has already completed the first four years of college, as this credit is only granted for the first four years of post-secondary education.
Lifetime Learning Credit—If a student does not qualify for the American Opportunity Credit, he or she may still qualify for the Lifetime Learning Credit. Key features of the credit include the following:
- The credit is available for all years of post-secondary education and for courses taken to acquire or improve job skills.
- There is no limit on the number of years that the Lifetime Learning Credit can be claimed for an eligible student.
- The credit amounts to $2,000 maximum per eligible student.
- The credit is non-refundable; thus, the maximum amount credited is limited to the amount of tax that must be paid on your return.
- The student does not need to be pursuing a degree or other recognized education credential to qualify for this credit.
- Qualified expenses include tuition and fees, course-related books, supplies, and equipment.
- The full credit is generally available to eligible taxpayers, in 2013, whose MAGI is less than $53,000, or $107,000 for married couples filing a joint return. Above these amounts, the credit quickly begins to phase out.
Only one type of education credit can be claimed per student in the same tax year. However, if you’re the parent of two children attending college, you can claim the American Opportunity Credit for one student and the Lifetime Learning Credit for the other. Note, however, that the Lifetime Learning Credit’s $2,000 cap applies on a per tax return basis.
The credit is claimed on the return of the individual who claims the student’s exemption. For example, if a student’s parents are divorced and the father pays the tuition but the mother claims the student’s exemption, the mother would receive the credit, even though the father made the payments.
Student loan interest deduction—Other than certain home mortgage interest, personal interest that you pay is generally not deductible. However, you may be able to deduct interest paid on a qualified student loan during the year. It can reduce the amount of your income subject to tax by up to $2,500, even without itemizing deductions. However, if your MAGI exceeds $75,000 ($155,000 if married filing a joint return), the student loan interest deduction is not allowed. If you’re married and filing separately, the deduction is not permitted, regardless of income level.
Determining the most beneficial education tax credit and applying other education expense strategies can be complicated and requires planning in advance. For assistance with these and other tax planning issues, please give this office a call.