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Daily Capital

Guide to Education Tax Credits & Deductions

“It’ll cost how much to send my child to college?”

Sound familiar? Have you said those exact words to yourself?

Anytime you take a look at college tuition costs, it can scare even the savviest saver. These costs can look even scarier when you’re the parent of a young child and you use a college savings calculator to project future costs of college.

In 2020-2021, tuition, room, board and fees cost $10,560 for in-state students at four-year public colleges, according to the College Board. The same costs for four-year private nonprofit institutions averaged $37,650 during the 2020-2021 academic year.

Luckily, you can find relief for shelling out thousands of dollars per semester. We’ll show you how, in the form of education tax credits and deductions.

Let’s go over education tax credits, examine who can claim an educational tax credit and the specific IRS forms you can use for taxes and education.

What Are Education Tax Credits?

How does tuition tax credit work? An education tax credit, sometimes called a college tax credit, helps with the cost of higher education by reducing the amount you owe in taxes. You can tap into two types of tax credits: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Let’s go over the two types of tax credits below.

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) allows you or your student to save money by reducing taxes on a dollar-for-dollar basis instead of just reducing the income subject to tax.

The eligibility requirements for the AOTC include the following. The student must:

  • Not have completed the first four years of postsecondary education.
  • Have been in school for at least one semester during the tax year.
  • Have at least half-time status in a program of study.
  • Not have a drug conviction on record.
  • Attend any type of postsecondary school that participates in the Department of Education’s financial aid program.

Qualifying expenses for the AOTC can include books, supplies and equipment. You cannot include the amount on your taxes that your student receives from tax-free scholarships, fellowships, Pell Grants and other nontaxable assistance you receive.

If you have multiple children in college at the same time, you can claim the AOTC for more than one child. You can get a maximum annual credit per student of $2,500 per student, 100% of the first $2,000 of qualified expenses plus 25% of the expenses in excess of $2,000. You must complete IRS Form 8863 and attach it to a personal income tax return to claim the credit.

Single taxpayers who have adjusted gross income between $80,000 and $90,000 can take the credit, as can joint tax filers with adjusted gross income between $160,000 and $180,000. Taxpayers whose adjusted gross income exceeds the $90,000 and $180,000 thresholds cannot take the credit.

Lifetime Learning Credit (LLC)

You can tap into the Lifetime Learning Credit (LLC) for qualified tuition and related expenses (such as fees and any books or supplies) paid for eligible students enrolled in a postsecondary educational institution, including undergraduate, graduate and professional degree courses. You can claim the credit for as many years as your student is in school — note that your child doesn’t have to work toward a degree.

You can claim the LLC up to the maximum of 20% of up to $10,000 in eligible costs, or $2,000.

At the end of the year, your educational institution should send you Form 1098-T that reports your costs. Enter those figures on IRS Form 8863 to claim your credit. Complete parts 3 and 6 to calculate the credit amount, transfer the credit amount to your income tax return and attach Form 8863 to your tax return.

You cannot claim the AOTC in the same year you claim the LLC. Note that the AOTC can give you more tax savings; the maximum amount you can claim for the American Opportunity credit is $2,500.

The LLC phases out if your modified adjusted gross income (MAGI) ranges between $59,000 and $69,000 or if you file a joint return, $118,000 and $138,000. You can’t claim the credit if your MAGI amounts to $69,000 or more ($138,000 or more for joint return filers).

Tuition and Fees Deduction

You can no longer get the tuition and fees deduction because the Consolidated Appropriations Act (CAA) repealed it.

However, you can achieve tax-advantaged savings in other ways. Let’s take a quick look at 529 plans and Coverdell education savings accounts (ESAs).

529 Plans

529 plans are operated by individual states. You can choose to go the prepaid tuition route or the investment savings plan route.

  • Prepaid tuition plan: Prepaid tuition plans allow you to pay ahead for tuition. You can buy four years of college now at today’s prices instead of paying the costs of college 18 years from now. However, you can only choose from an in-state public institution, you only cover tuition (not room, board and fees) and your state might shut down the program.
  • Investment savings plan: An investment savings plan allows you to invest in stocks, bonds and mutual funds. Your child isn’t restricted to attending a certain school like in a prepaid tuition plan. You can choose to invest more conservatively or aggressively, depending on the age of your child. However, it’s important to note that you can lose money through your investments.

Many states allow full or partial tax deductions in the form of income state tax deductions and state tax credits. Your investment grows on a tax-deferred basis and you can withdraw money tax free when it’s time for your child to head off to college. You cannot deduct contributions from your federal income taxes.

When your beneficiary attends college, distributions are tax exempt if you use them to pay for qualified expenses. Under the Tax Cuts and Jobs Act (TCJA), you can use a 529 plan to pay up to $10,000 in tuition at an elementary or secondary school. You can also use that same amount to pay for student loans.

By federal law, contributions to a 529 plan cannot exceed the expected cost of your beneficiary’s stated college expenses. Limits vary by state and can range from $230,000 to $530,000.

Coverdell Education Savings Accounts (ESAs)

Anyone can contribute up to $2,000 a year to a Coverdell Education Savings Account (ESA) for a named beneficiary. A Coverdell ESA is a trust or custodial account that pays for qualified education expenses. You won’t pay taxes on your future earnings or distributions for qualified expenses, such as tuition, room, board and fees.

You can only contribute $2,000 per year to a Coverdell ESA. You must have an income of less than $110,000 ($220,000 filing jointly).

Scholarships

Have you ever thought of scholarships as tax exempt? As long as your student has been accepted to an eligible institution and the scholarship goes toward eligible expenses (tuition, room, board and fees).

However, note that you’ll have to pay taxes on the amount earned for scholarships if you use it for unqualified purposes, such as car repairs.

Learn as much as you can about education tax credits and deductions from your accountant or tax professional — this person will guide you to understand what you’re eligible for.

Who Can Claim an Education Credit?

At this point, you’re probably wondering whether you’re eligible to claim an education tax credit. After all, beyond the details, you probably just want to get to the nitty-gritty and claim the education tax credit, already! Let’s take a look at who can claim an education tax credit. You can claim it if:

  • You, your dependent or someone else (such as a grandparent) pays for qualified education expenses for higher education.
  • Your student is enrolled at an eligible postsecondary educational institution.
  • You list the dependent student on your tax return — the student could be yourself or your spouse as well.

On the other hand, you cannot claim an education tax credit if:

  • Someone else lists you as a dependent on his or her tax returns.
  • You have a married filing separately status.
  • You claimed or deducted another tax benefit — you cannot double-dip into both types of education tax credits.
  • You don’t meet the income requirements.
  • You are a non-resident alien, not a resident alien for tax purposes

One more thing: The IRS says only a parent or student can claim an education tax break — both cannot take the credit. Make sure you talk to your child about who should claim the credit on your respective tax return.

Education Tax Forms

Let’s take a look at the education tax forms you’ll need to accomplish your goals. You can get these education tax forms from the IRS website.

Form 1098-T

But first, your student should receive Form 1098-T from his or her postsecondary institution every year. Colleges, universities and vocational schools that participate in the Department of Education’s financial aid program should send this out. The form provides information about how much you’ve spent on educational expenses to determine whether you or your student qualifies for education tax credits.

Schools must send a list of qualified expenses, which include tuition, fees and course material costs required by each class for enrolled students.

Schools send the form to the student by January 31 each year in time to pay for that year’s taxes. Take a look at a few notes about form 1098-T:

  • Box 1: Schools report the amount paid in Box 1 on the form.
  • Box 2: Box 2 is now blank; it used to report the amount billed.
  • Box 3: Box 3 reports whether a school changes its reporting method. If it changes its method, it checks Box 3. This box primarily exists for IRS use.
  • Box 4: Box 4 shows any adjustments the school has made to qualified expenses.
  • Box 5: Box 5 reports the amount of scholarships and grants paid directly to the school. Scholarships and grants may reduce the amount of qualified expenses related to a deduction or credit. In fact, if the amount in Box 5 is greater than the amount in Box 1 or 2, you cannot use expenses to reduce your tax bill.
  • Box 6: Box 6 shows any adjustments the school has made to scholarships and grants reported on a previous year’s 1098-T. These adjustments may affect the student’s tax liability for the previous year, so the student may have to file an amended return.
  • Box 7: Box 7 reports whether the amount in Box 1 or 2 includes expenses for an academic term beginning within the first three months of the year following the year that the 1098-T covers.
  • Box 8: This box indicates whether the student has enrolled at least half-time in an academic program.
  • Box 9: This box indicates whether the student has enrolled in a graduate program.
  • Box 10: When students have expenses reimbursed after under a tuition insurance policy due to withdrawing from school for medical reasons or family emergencies.

Form 8863

You can use Form 8863 to figure out and claim your education credits for the AOTC and the LLC. Enter the student’s name and Social Security number on the two-page form. A refundable credit can give you a refund when the credit amounts to more than the tax you owe. On the other hand, a nonrefundable credit can reduce your tax bite but you don’t get money refunded to you.

Your tax advisor can help you walk through this form.

What if I Don’t Qualify for Tax Credits and Deductions?

What should you do if you don’t qualify for tax credits and deductions? Maybe your income is too high — again, you can’t get the deduction if your modified adjusted gross income goes above $80,000 ($160,000 for joint filers). Maybe you’re ineligible because you and your spouse file separate tax returns or you qualified as a nonresident alien for a portion of the tax year.

If you don’t qualify, you or your child can look forward to student loan tax deductions in the future or can take advantage of the tax benefits through a 529 plan or Coverdell ESA. Back to the student loan deduction: If you have student loans, you can deduct some or all of the interest paid during the tax year.

The student loan interest tax deduction allows you to deduct the lesser value of $2,500 or the amount of interest you paid. Can you qualify based on any type of loan you pay back?

Yes! You can qualify based on federal and private student loan interest. Take a look at a few of the qualifications:

  • You must meet certain qualifications to qualify for the deduction:
  • You must be legally obligated to repay a qualified student loan.
  • Your filing status cannot be married filing separately.
  • If your MAGI is between $70,000 and $85,000, you’ll be subject to a reduced deduction.
  • You can’t claim the deduction at all if your MAGI is $85,000 or more (or $170,000 if filing a joint return).

Again, your accountant or tax advisor can help you through this process and help you understand whether you qualify.

Do You Qualify for an Education Tax Credit?

Though you know your child receives a leg up in his or her chosen profession with a college education, college costs can amount to one of the priciest undertakings you experience, no matter how many guides to saving for a child’s education you read.

After reading all of this information, do you qualify for a college tuition tax deduction or credit? It’s important not to take advantage of everything you possibly can, because a child’s college education can put a huge hit on your budget or savings. Don’t overlook these tax deductions and credits.

Check out Personal Capital’s College Financing Guide for a comprehensive guide to saving for college. Personal Capital also offers free and secure online financial tools, including an Education Planner.

Millions of people use these tools to see all of their accounts in one place, analyze their investments and uncover hidden fees, and plan for long-term goals, like funding college or saving for retirement. Personal Capital’s financial tools are completely free.

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Personal Capital compensates Melissa Brock (“Author”) for providing the content contained in this blog post. Compensation not to exceed $500. Author is not a client of Personal Capital Advisors Corporation. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Third party data is obtained from sources believed to be reliable; however, Personal Capital Corporation (“PCC”) cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Personal Capital of the contents on such third party websites.

Melissa Brock spent 12 years in college admission and is the founder of College Money Tips. She also writes financial content and loves helping families navigate the college search process.
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