How Can I get Tax Deductions and Credits When Paying for College?
One of the most frequently asked questions that College Coach experts are asked is, “Can I deduct the payments I make for my child’s college tuition expenses?” This relatively straightforward question does not have a straightforward answer, but with careful planning families can take advantage of tax breaks that are designed to help them pay for their family’s higher education expenses.
For most parents of traditional undergraduate students, the biggest available tax break is the American Opportunity Credit (AOC). Taxpayers who qualify for the AOC may receive a $2,500 credit if they pay $4,000 or more in tuition, required enrollment fees, and course materials that the student needs for a course of study. Credits are better than deductions: they reduce the family’s tax liability dollar for dollar!
In order to claim the full AOC, a taxpayer must claim an undergraduate student as a dependent on their income tax return and have a modified Adjusted Gross Income (mAGI) less than $80,000 (if they are a single taxpayer or head of household) or $160,000 (if they are married filing jointly). Taxpayers with mAGIs as high as $90,000 (single/head of household) or $180,000 (married filing jointly) can take a reduced credit.
The AOC is a complicated tax break with many rules. For example, the student must be a candidate for a degree or certificate, enrolled at least half-time at an eligible institution, and must be in his or her first four years as an undergraduate. The payment for the qualifying $4,000 in tuition and related fees must be paid for with funds that do not otherwise give the payer a tax benefit. This restriction means that payments made with scholarships, which are tax-free to the student when they cover tuition, related fees, or course materials, or with a tax-free distribution from a 529 savings plan, most prepaid tuition plans, or a Coverdell Education Savings Account (ESA) do not qualify as payments counted toward AOC eligibility.
It is possible for some taxpayers who have incomes that are too high to claim the AOC to set up their finances in a manner that allows the student himself or herself to claim the credit. For this process to work, the student must meet the IRS’s rules for being able to claim themselves on their own income tax returns and must have an income tax liability to be offset by the AOC. Also, for families who have students with tax-free scholarships or are planning to use 529 plans, prepaid tuition plans, or ESAs to pay for college, careful planning to coordinate how each of these tax-advantaged higher education benefits is applied against the student’s bill can ensure the family receives the maximal possible benefit across the board. Finally, some states offer state tax deductions or credits for their taxpayers who pay for a dependent’s tuition.
A second tax break, called the Lifetime Learning Credit, is smaller than the AOC, but available to graduate students and students taking classes at eligible colleges who might not be pursuing a degree or certificate there, but are instead working toward acquiring or improving job skills. It has tighter income restrictions, but is worth investigating for students casually taking classes to acquire or improve their employment-related education.