The choice to attend college is a decision that comes at a high cost. Every year, tuition, fees, and room and board steadily increase. The cost of a college education has almost doubled in the last decade. Therefore, these rising college costs can be a major challenge for students and parents. The financial strain of attending college has produced an all-time high of U.S. student debt.
There are a few education-related tax credits and deductions you should know about that give parents and students much-needed relief from these expenses. Waters Hardy is a personal accounting tax resource that can help you. Our expert accounting services team focuses on tax preparation and compliance to find ways to offset the rising costs of college for students and parents.
Education Tax Credits for College Students and Parents
Rather than just reducing the amount of income subject to tax, tax credits apply directly toward the amount of tax you owe. Two college tax breaks provide relief in the form of tax credits. Although you can’t take both credits for the same dependent, you can claim different credits for each of your dependents during the same tax year. It is important to understand which will benefit you most. Here is some information to help you decide which would be the best for your situation.
American Opportunity Tax Credit (AOTC)
The AOTC allows parents with dependents and independent students to reduce their tax bill by up to $2,500 for up to four years. Additionally, up to 40%, or $1,000 of your credit, is refundable even with no tax liability. For parents of a college student, you can take this tax credit four times per eligible dependent. As a refundable tax credit, the AOTC can increase the size of your tax refund even if it reduces your tax liability to a negative number.
Independent students and parents, with qualified education expenses for undergraduate courses can qualify for the American Opportunity Tax Credit. The amount you’re allowed to claim depends on your modified adjusted gross income (MAGI). To receive the full $2,500 credit, your MAGI cannot be higher than $90,000 for single filers, or $180,000 for those filing jointly.
Lifetime Learning Credit (LLC)
Unlike the AOTC, the LLC is an up to $2,000 per year, nonrefundable tax credit, meaning you can’t receive any of the credit back as a refund. Most of the time, the AOTC is the better claim, but the LLC can still be useful in certain situations. For example, the LLC allows for tax credits claimed for undergraduate, graduate, or technical school expenses. In addition, there is no rule stating that the LLC can only be claimed for a certain number of years, and you don’t need to be enrolled full-time to be eligible.
The full $2,000 Lifetime Learning Credit requires less than a $69,000 MAGI for single filers and a $138,000 MAGI for joint filers. Two stipulations can make you ineligible for the tax credit- if your filing status is married filing separately or if you were a nonresident alien during the year and/or someone else is claiming you (or the student you paid for) as a dependent.
Education Expenses That Do Qualify for a Tax Credit
- Tuition and fees
- Other equipment necessary for your course of study
Education Expenses That Do Not Qualify for a Tax Credit
- Room and board
- Health fees
- Living expenses
Working Student Tax Credits
The Earned Income Tax Credit is a refundable write-off for low-to-moderate-income workers. Suppose working students can afford to save some of their earnings. In that case, they may also qualify for the Retirement Savings Contributions Credit, applying up to 50% of deposits for a maximum of $1,000 for single investors.
Tax Deductions for College Students and Parents
Unlike credit, tax deductions lower your tax liability by reducing the amount of income subject to tax. Deductions are not as valuable as college tax credits, but they can still be beneficial and serve to reduce the amount of tax you owe. A lower adjusted gross income can also help you qualify for other deductions and credits.
Student Loan Interest Deduction
This tax break, which helps after graduation, is for students and parents and is worth the amount paid in interest for student loans, up to the maximum $2,500 deduction. To qualify, you must have paid the interest during the tax year on qualified student loans used solely to pay higher education costs for you, your spouse, or a dependent.
Private loans do not count toward the deduction, and students must be enrolled at least part-time. Additionally, your MAGI must be less than a certain amount, set annually and gradually reduced depending on income.
Different Ways to Save and Prepare for College Expenses
Educational Savings Accounts
- Coverdell Education Savings Account
- 529 Savings Plan
These savings plans offer tax-free earnings growth and tax-free withdrawals when funds are used for qualified educational expenses. The account holder is exempt from paying tax on the annual growth on the original investment. This applies only if the money is used to cover education expenses. Then, no tax is paid on withdrawn funds.
Education Savings Bond Program
You can exclude the interest from income when saving bonds are redeemed to pay for higher education expenses.
While pulling from an IRA is not typically recommended, there are some tax benefits for college expenses if you must. Rather than paying the 10% penalty if you withdraw funds early (before you reach 59 and a half), it can be withdrawn without penalty if you use that money to pay for tuition and other qualified higher education expenses.
Achieve Optimal Tax Benefits with the Help of Our Professional Tax Team
Rising college costs are out of your control, but these tax breaks can help offset the cost and lessen your financial burden. If you want to learn more about identifying which educational tax breaks you could qualify for as a student or parent, contact the professional accounting service team at Waters Hardy. With the help of our tax planning experts, we can ensure the maximum tax benefit on your college expenses.