Tax Benefits of Higher Education: Frequently Asked Questions
Table of Contents
A wide variety of tax relief is available, but you'll need to choose which credit or deduction to claim or which savings plan to use based on your individual tax situation. You also can't use two different kinds of relief for the same item. For instance, you can't take the higher education credit and tuition fees deduction for the same student for the same year. You also can't take the American Opportunity Credit and the Lifetime Learning Credit for the same student for the same year. There may also be limits based on adjusted gross income.
Two tax credits are available for education costs - the American Opportunity Credit (formerly the Hope Credit) and the Lifetime Learning Credit. These credits are available only to taxpayers with adjusted gross income below specified amounts, see Income Phase-Outs, below. Both credits were made permanent by the Protecting Americans from Tax hikes Act of 2015 (PATH).
How Do These Credits Work?
The amount of the credit you can claim is either, $0, $2,000, or $4,000 and depends on (1) how much you pay for qualified tuition and other expenses for students and (2) your adjusted gross income (AGI) for the year.
You must report on Form 8863 the eligible student's name and Social Security number on your return to claim the credit. You subtract the credits from your federal income tax. If the credit reduces your tax below zero, you cannot receive the excess as a refund. If you receive a refund of education costs for which you claimed a credit in a later year, you may have to repay ("recapture") the credit.
Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.
"Related" expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.
Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another person's dependent can't claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.
No "double-dipping." The tax law says that you can't claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.
Income limits. To claim the American Opportunity Credit, for example, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $66,000 ($132,000 for joint filers). "Modified AGI" generally means your adjusted gross income. The "modifications" only come into play if you have income earned abroad.
The American Opportunity Tax Credit
The American Opportunity Tax Credit (AOC) was made permanent starting with tax-year 2015. The maximum credit, available only for the first four years of post-secondary education, is $2,500. You can claim the credit for each eligible student you have for which the credit requirements are met.
Special qualification rules. In addition to being an eligible student, he or she:
Amount of credit. The maximum amount of the AOC is $2,500. Generally, 40 percent of the AOC is now a refundable credit for most taxpayers, which means that you can receive up to $1,000 even if you owe no taxes.
The Lifetime Learning Credit
You may be able to claim a Lifetime Learning Credit of up to $2,000 (20 percent of the first $10,000 of qualified expense) for eligible students (subject to reduction based on your AGI). Only one Lifetime Learning Credit can be taken per tax return, regardless of the number of students in the family.
Choosing the Credit. You can't claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year - for example, an AOC for your child and a lifetime learning credit for yourself.
Electing Not to Take the Credit. There are situations in which the credit is not allowed, or not fully available, if some other education tax benefit is claimed - where the higher education expense deduction is claimed for the same student, see below, or where credit and tax exemption (under a Section 529 or 530 program) are claimed for the same expense. In that case, the taxpayer - or, more likely, the taxpayer's tax adviser - will determine which tax rule offers the greater benefit and if it's not the credit, elect not to take the credit.
For an academic period (quarter, semester, etc.) beginning in the first 3 months of a calendar year, you can pick which year to pay the expense and take the credit. That is, pay in December 2018 and take the credit in 2018 or pay in, say, February 2019 and take the credit in 2019.
Your family may be able to save tax by foregoing the education credit and taking an available exemption for program distributions instead.
Sometimes. Examples are for relief provided for Coverdell Education Savings Accounts (Section 530 programs), for Qualified Tuition Programs (Section 529), for withdrawals from traditional and Roth IRAs, and for student loans.
An education IRA differs from other IRAs in the following ways:
A 530 account may be used for primary and secondary education, including paying for room and board of children in private schools, and for computers and related materials whether or not away from home.
There can be a number of Section 530 accounts for any student. Various family members, such as grandparents, aunts, and uncles, and siblings--and persons outside the family--can contribute to separate accounts for a student.
The original student beneficiary for the Section 530 account can be changed to another family member, such as a sibling--for example where the original beneficiary wins a scholarship or drops out.
Funds can be rolled over tax-free from one family member's Section 530 account to another's for example, to avoid distribution when the first family member reaches age 30.
The education tax credit (where applicable) can be waived in favor of tax-free treatment for Section 530 account distributions.
Also called Section 529 plans, these college savings plans have been established by almost every state and some private colleges. You invest now to cover future college or vocational school expenses, by contributing to a savings account or buying tuition credits redeemable in the future. Investments grow tax-free, and distributions to pay college expenses can also be tax-free. You may choose any state's plan, regardless of where you live. Starting in 2018, funds from 529 plans can be used for up to $10,000 of qualified expenses related to K-12 education as well.
How do Coverdell Education Savings Accounts (Section 530) and Qualified Tuition Plans (Section 529) differ?
Section 530 plans limit investment to $2,000 a year per student; 529 plans allow a much larger investment. Section 530 plans allow a wide choice of investments; 529 investment choices are limited and conservative. Section 530 is a single nationwide program, whereas each 529 program is different. Both are available for higher education as well as primary and secondary education.
Yes. The 10 percent penalty on withdrawal under age 59-1/2 won't apply, but ordinary income tax will apply to at least some of the withdrawal.
Yes, generally under the same terms as traditional IRAs. Also, ordinary income tax is somewhat less likely or may be smaller in amount, than with traditional IRAs.
You can choose to take a tax deduction rather than the college tuition tax credits noted above. A tax deduction is usually taken if income is too high for the tax credits. The tax deduction reduces your amount of income. The tax credits reduce the amount of tax you pay.
A $4,000 above the line deduction for qualified tuition expenses was extended through tax-year 2017 by the Bipartisan Budget Act but unless extended by Congress, starting in 2018, the deduction will no longer be available.
A business expense deduction is also allowed without dollar limit, for education that serves the taxpayer's business, including employment. The deduction is also allowed for student loan interest; however, a taxpayer may not take more than one deduction for the same item.
If it's not part of a degree or certificate program, and not work-related, the limited deduction (up to $4,000 for qualified tuition and fees) may be your only option; however, please note that this deduction expired at the end of 2017. Again, unless reauthorized by Congress for tax year 2018 (or beyond), the deduction is not available starting in 2017. The deduction amount depends on your income. Some sideline interests might qualify for exclusion if paid for under an employer-provided education assistance program.
Since personal interest is generally non-deductible, deductions must meet several tests:
For tax years prior to 2018, you could deduct interest form a home equity loan used to pay educational and other non-home improvement-related expenses, not as student loan interest. In this case, there was no income ceiling on your deduction, and certain other student loan limits didn't apply. However, for tax years 2018 through 2025, taxpayers are no longer able to deduct interest on home equity loans taken out for non-home-related purposes.
Usually you're taxed on the unpaid loan balance, but the tax can be waived if the debt is canceled if you worked:
Tax reform legislation passed in 2017 further stipulated that student loan debt forgiveness due to death or permanent and total disability is excluded from income.
Interest on redemption of Series EE bonds is tax-exempt if you redeem them in a year you have qualified education expenses. Exemption depends on the amount of your income in the year you redeem the bond.
Maybe not. Starting in 2013, up to $5,250 can be tax-free. Exemption can apply to graduate level courses.
For tax years prior to 2018, the answer was, yes, if it's to maintain or improve skills in your present job, but no, if it was to meet minimum requirements of that job, or to qualify to enter a new business. Furthermore, employee's deductions were subject to the two percent floor on miscellaneous itemized deductions. However, under the Tax Cuts and Jobs Act of 2017 ("tax reform"), for tax years 2018 through 2025, employee business-related deductions (including education expenses) are disallowed. That is, there are no miscellaneous deductions on Schedule A as there were previously. Self-employed individuals are still able to deduct qualifying educational expenses on Schedule C.