Tax credits, deductions and savings plans can help taxpayers with their expenses for higher education.
An education credit helps with the cost of higher education by reducing the amount of tax owed on your tax return. There are two education credits available: the American opportunity tax credit (AOTC) and the lifetime learning credit. If the American opportunity tax credit reduces your tax to less than zero, you may get a refund.
Who Can Claim an Education Credit?
Additional rules exist for each credit; therefore, you must meet all three of the following for either credit:
If you’re eligible to claim the lifetime learning credit and are also eligible to claim the American opportunity credit for the same student in the same year, you can choose to claim either credit, but not both. You can't claim the AOTC if you were a nonresident alien for any part of the tax year unless you elect to be treated as a resident alien for federal tax purposes. The law requires that both you and your qualifying student have a valid Social Security number or Individual Taxpayer Identification Number, issued before the due date for your tax return, in order to claim the AOTC.
Tuition and Fees Deduction: You may be able to deduct qualified education expenses paid during the year for yourself, your spouse or your dependent instead of a tax credit. You cannot claim this deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax return. The qualified expenses must be for higher education.The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000. This deduction is taken as an adjustment to income. This deduction may be beneficial to you if, for example, you don’t qualify for the American opportunity or lifetime learning credits. Or, if you qualify for both the tax credit or deduction, then you can choose which one gives you the best tax benefit. You cannot claim the tuition and fees deduction as well as an education credit for the same expense.
Student Loan Interest Deduction: Generally, personal interest you pay, other than certain mortgage interest, is not deductible on your tax return. However, if your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return), a special deduction exists for interest paid on a student loan (also known as an education loan) used for higher education. Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntary interest payments.For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500.
Qualified Tuition Programs (529 plans): States may establish and maintain programs that allow you to either prepay or contribute to an account for paying a student's qualified education expenses at a postsecondary institution. Eligible educational institutions may establish and maintain programs that allow you to prepay a student's qualified education expenses. If you prepay tuition, the student (designated beneficiary) will be entitled to a waiver or a payment of qualified education expenses. You can't deduct either payments or contributions to a QTP. No tax is due on a distribution from a QTP unless the amount distributed is greater than the beneficiary's adjusted qualified education expenses. Qualified expenses include required tuition and fees, books, supplies and equipment including computer or peripheral equipment, computer software and internet access and related services if used primarily by the student enrolled at an eligible education institution. Someone who is at least a half-time student, room and board may also qualify.
Coverdell Education Savings Account: A Coverdell ESA can be used to pay either qualified higher education expenses or qualified elementary and secondary education expenses. Income limits apply to contributors, and the total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary is someone who is under age 18 or is a special needs beneficiary. Contributions to a Coverdell ESA are not deductible, however, amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to qualified higher education expenses as well as to qualified elementary and secondary education expenses.
Some things to remember about distributions from Coverdell accounts:
A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student may be either an undergraduate or a graduate. A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. Generally, whether the amount is tax free or taxable depends on the expense paid with the amount and whether you are a degree candidate.
A scholarship or fellowship is tax free only if you meet the following conditions:
Qualified Education Expenses: For purposes of tax-free scholarships and fellowships, these are expenses for:
However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.
Expenses that Don’t Qualify: Qualified education expenses do not include the cost of:
This is true even if the fee must be paid to the institution as a condition of enrollment or attendance. Scholarship or fellowship amounts used to pay these costs are taxable.
You may exclude certain educational assistance benefits from your income so you won’t have to pay any tax on them. However, it also means that you can’t use any of the tax-free education expenses as the basis for any other deduction or credit, including the lifetime learning credit.
Educational Assistance Program: To qualify as an educational assistance program, the plan must be written and must meet certain other requirements. Your employer can tell you whether there is a qualified program where you work.
Educational Assistance Benefits: Tax-free educational assistance benefits include payments for tuition, fees and similar expenses, books, supplies, and equipment. The payments may be for either undergraduate- or graduate-level courses. The payments do not have to be for work-related courses. Educational assistance benefits do not include payments for the following items.
Benefits over $5,250: If your employer pays more than $5,250 for educational benefits for you during the year, you must generally pay tax on the amount over $5,250. Your employer should include in your wages (Form W-2, box 1) the amount that you must include in income.
Working Condition Fringe Benefit: However, if the benefits over $5,250 also qualify as a working condition fringe benefit, your employer does not have to include them in your wages. A working condition fringe benefit is a benefit which, had you paid for it, you could deduct as an employee business expense.