What to Know About Educational Tax Credits and Deductions
College is expensive, but several valuable tax breaks can help ease the pain. You may be able to cut your tax bill by up to $2,500 if you’re paying college tuition, and you may even get tax credits to help cover the cost of continuing education classes to improve your job skills. Interest you pay on student loans may be tax-deductible, and you can use tax-advantaged savings to pay for a computer or private school, in addition to college costs. Recently expanded benefits can help families with new education needs because of the coronavirus pandemic, and some strategies can help you make the most of these tax breaks to stretch your savings.
American Opportunity Credit for College Costs
The American Opportunity Credit can cut your tax liability by up to $2,500 if you’re paying for the first four years of higher education for yourself, your spouse or a dependent you claim on your tax return. To qualify for this credit, the student must be enrolled at least half time and pursuing a degree or other recognized educational credential at a college, university, vocational school or other eligible postsecondary educational institution.
To claim the full credit, your modified adjusted gross income, or MAGI, must be $80,000 or less if single or filing as head of household or $160,000 or less for married couples filing jointly. You can claim a partial credit if your MAGI is less than $90,000 if filing as single or as head of household or $180,000 if married filing jointly. The credit is calculated as 100% of the first $2,000 of qualifying expenses, plus 25% of the next $2,000 – making the maximum credit $2,500 per student.
Eligible expenses include tuition, books, supplies and equipment (which don’t have to be purchased from the institution) and student activity fees paid to the university if required as a condition of enrollment, says Jane Rubin, a CPA in St. Louis and member of the American Institute of CPAs Financial Literacy Commission.
Lifetime Learning Credit for Grad School and Continuing Education
If you’re going to grad school or taking any continuing education classes – even if you aren’t working toward a degree – you may be eligible for the Lifetime Learning Credit. This credit is worth 20% of up to $10,000 in eligible expenses, with a maximum credit of $2,000 per tax return.
“Having multiple individuals in college does not get you additional credits,” says Tracie Miller-Nobles, CPA, consumer financial education advocate for the American Institute of CPAs and a professor at Austin Community College. Eligible expenses include tuition and fees that are required for attendance for yourself, your spouse or a dependent you claim on your tax return.
To qualify for the full credit in 2020, your MAGI must be less than $59,000 if single or head of household or $118,000 for joint filers. You can claim a partial credit if your MAGI is less than $69,000 if filing as single or head of household or $138,000 for married filing jointly. There’s no limit to the number of years that you can claim the Lifetime Learning Credit.
You can take the Lifetime Learning Credit for graduate school or undergraduate expenses, and you don’t have to be enrolled at least half time. You can also claim the credit for continuing education, certificate programs or separate classes you take to acquire or improve job skills. This credit is available for an unlimited number of tax years.
“You don’t have to be working toward a degree,” says Rubin. The key is that the class must be offered by an eligible educational institution, including any college, university, vocational school or other post-secondary educational institution eligible to participate in a federal student aid program run by the U.S. Department of Education.
This credit can be valuable for people who lost their jobs or were furloughed in the past year and took classes to improve their job prospects. “Courses to acquire new skills may be especially relevant right now,” says Melody Thornton, a CPA in San Diego, California.
You’ll usually receive Form 1098-T from the eligible institution reporting the qualified expenses paid. To claim the credit, complete Form 8863.
Deduction for Student Loan Interest
If you’re paying back student loans, you may be able to deduct up to $2,500 in student loan interest. “The interest deduction goes to the person legally obligated to pay the interest,” says Tim Todd, CPA, and member of the American Institute of CPAs financial literacy commission.
“So if a parent takes out the loan for their child and the parent makes the interest payments, the parent gets the deduction. However, if a student takes out the loan and the parent pays the interest, it is treated as though the parent transferred the money to the student who then makes the payment.” The student can’t get the break, however, if they’re claimed as a dependent by the parents.
To qualify for the deduction in 2020, your MAGI must be less than $85,000 if single or head of household, or $170,000 if married filing jointly. The size of the deduction starts to phase out if your MAGI is more than $70,000 if single or head of household, or $140,000 if married filing jointly. You don’t have to itemize to claim the student loan interest deduction.
Maximizing 529 Tax Breaks for Education at All Ages
You can withdraw money tax-free from a 529 savings plan for college tuition, fees and equipment such as a computer or printer. You can also withdraw money tax-free for room and board if you’re enrolled at least half time, even if you don’t live on campus. Eligible expenses for off-campus housing are generally limited to the room and board costs that the college reports for financial aid purposes; look for the number on the financial aid page or ask the aid office.
“For example, if the room and board cost reported by the school is $15,000 but it costs $30,000 for the student living off campus, then only $15,000 is a valid 529 expense,” says Thornton. You can also withdraw money tax-free for a computer, whether you attend school on campus or virtually, which has become particularly important in 2020 and 2021. The cost of computer programs the student uses for school is also an eligible expense. “As long as the student is using it for 529-related coursework, then you can use the 529 for those expenses,” says Mary Morris, CEO of Virginia529.
There’s no age limit for using the money, and you don’t need to be working toward a degree. “One of the really important things we see are adults going back to school – maybe they lost their job and are taking classes or a certificate program that puts them on a road to a new career,” says Morris.
You can withdraw money tax-free from a 529 for those expenses, as long as you’re taking the classes from an eligible educational institution. You’ll get the biggest tax benefits if you can keep the money growing in the tax-advantaged account for years. But if you don’t already have a 529, it may still be worthwhile to open an account and make the most of any tax break for contributions, even if you plan to use the money soon for education expenses. For example, Virginia 529 account holders can deduct up to $4,000 in contributions from their taxable income in Virginia each year.
Thirty-four states and the District of Columbia offer tax benefits for 529 contributions, according to AKF Consulting Group, a municipal advisor to state administrators of 529 plans nationwide. Of those states, 27 offer the deduction or credit for any taxpayer who contributes to a 529 plan; seven states and the District of Columbia only offer the break to the account owner. You generally have to contribute to your own state’s 529 to get the tax break, although Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania offer a break if you contribute to any state’s plan, according to AKF Consulting Group.
Also, you can now withdraw up to $10,000 per year per beneficiary tax-free to pay tuition for kindergarten through 12th grade from a 529, a provision that was added in 2018. Morris says this has been popular recently with families who switched their children to private schools to attend in-person classes while many public schools were remote or hybrid because of COVID. “This can help with an unanticipated cost during a time when some families may have reduced income,” she says.
If your child doesn’t use the money for educational expenses, you can switch the beneficiary to another eligible family member. If you take withdrawals that aren’t for eligible education expenses, the earnings are taxable and subject to a 10% penalty, although the penalty is waived in some circumstances.
“If a child receives a scholarship, a distribution for up to the amount of the scholarship can be made without being subject to the 10% penalty,” says Miller-Nobles. “The taxpayer must, though, still pay tax on the earnings of this distribution.” Even if your child qualifies for a scholarship, you may still have other eligible expenses that qualify for tax-free withdrawals, such as room and board, fees, books or a computer.
Coordinating Tax Credits for Education With Tax-Free 529 Withdrawals
You can qualify for the American Opportunity Credit or Lifetime Learning Credit and take tax-free 529 withdrawals in the same year, but you need to be careful. “You can’t use the 529 distribution for the same expenses,” says Todd. “In short, you can’t ‘double dip.'”
For example, if you claim the full American Opportunity Credit, then the $4,000 in tuition and fees you claim for the credit is not considered a qualified education expense for your 529, and part of the distribution may be taxable.
If you claim the full Lifetime Learning Credit, you can’t take tax-free 529 withdrawals for the first $10,000 in tuition expenses you claimed for the credit, but you can withdraw money tax-free from the 529 for additional expenses. “If you withdraw money from the 529 plan and are possibly eligible to claim a credit, make sure to keep receipts for all costs so that they maximize the benefits between the 529 and the credit,” says Thornton.