Educational Tax Benefits
Thanks to the Taxpayer Relief Act of 1997, families who are paying for higher education or repaying educational loans may be eligible for tax benefits that make higher education more accessible and affordable.
For complete details about these programs, read IRS publication 970. You can also contact your tax adviser or the IRS Help Line (1-800-829-1040) for additional information.
Tax Credits
The American Opportunity Tax Credit
Those eligible (there are income limitations) will qualify for the maximum annual credit of $2,500 per student. The credit is only allowed for the first four years of post-secondary education. Tuition, related fees, books and other required course materials generally qualify.
The Lifetime Learning Tax Credit
People not eligible for the American Opportunity credit may be eligible for this tax credit. It is targeted to students who want to return to school, as well as college juniors, seniors, graduate and professional degree students. The student may be enrolled full-time, half-time or less than half-time, and are not required to be in a degree-seeking program.
The taxpayer may claim only one Lifetime Learning Tax Credit per year ($2,000 maximum), but it may be claimed for an unlimited number of years. Dependent students may not claim the credit.
Tax Deductions
Tuition and fees deduction
If you do not qualify for the American Opportunity or the Lifetime Learning tax credits because of income limitations, you may be eligible for the tuition and fees deduction. This deduction allows you to reduce the amount of your income subject to tax by $4,000, and it can be claimed even if you do not itemize deductions on your taxes.
Education loan interest deduction
Taxpayers who have taken out loans to pay the cost of attending an eligible educational institution for themselves, their spouse or their dependent(s) generally may deduct the interest paid on these loans.
To be eligible, a loan must have been used to pay tuition, fees, room, board, fees and books expenses at an eligible educational institution. The student must have enrolled at least half-time in an undergraduate or graduate program leading to a degree or certificate.
The deduction is not only for federally guaranteed loans, but for any loan meeting the eligibility requirements including loans issued by schools, banks and not-for-profit associations. The deduction amount varies depending on your income, with the maximum deduction being $2,500 each year.
Educational Saving Options
Coverdell Education Savings Accounts
This program is a savings strategy in which contributions meant for higher education can grow tax-free. Family members (including parents, grandparents and even friends) are allowed to contribute up to $2,000 per year into an IRA for each child under the age of 18.
Eligibility requirements restrict joint tax filers with adjusted gross income of $220,000 or more from participating ($110,000 or more for single filers). Withdrawals from the education IRA may also be tax free if the funds are used toward the beneficiary's qualified higher educational expenses, which can include tuition, books, room and board, and required supplies.
Qualified tuition plans
Save for tuition and certain room and board charges — and get help from your parents, grandparents and friends! With qualified tuition plans, you can save for your education without being taxed until the money is withdrawn.
Prepaid tuition plans are college savings plans guaranteed to increase in value at the same rate as college tuition. They are exempt from federal income taxes and, in some cases, from state and local income taxes. The value of this plan is counted as an asset of the owner when completing the FAFSA, unless the owner is a dependent student.
The 529 College Savings Plan allows you to save for college tax-free and tends to have a low impact on the need-based financial aid eligibility. Unlike prepaid tuition plans, there is no lock on tuition rates. The value of this plan is counted as an asset of the owner when completing the FAFSA, unless the owner is a dependent student.