Tax Benefits Overview: Making College More Affordable Through Tax Savings
The federal government has created a number of ways to help reduce the tax burden of those paying for college or repaying college loans. All together, these ways can add up to significant savings. Below are summaries of different options that students and parents have at their disposal for reducing taxes. The IRS publication, Tax Benefits for Education, gives in-depth information about eligibility and tax filing requirements.
Tuition and Fees Tax Deduction
Grant, scholarship and fellowship awards are tax-free if the student is a candidate for a degree at an eligible institution. Awards used to pay for tuition, fees, books, supplies and equipment that are required for a course are all tax free. However, award money that is used to pay for room and board, travel, research, clerical help or equipment not required for the course is all taxable.
Tuition reductions, such as free or reduced tuition for an employee of a school, are generally tax-free. For graduate students, a tuition reduction is tax-free only if they do research or teach at the school.
The American Opportunity Tax Credit
Formerly known as the Hope Tax Credit, this is an income credit for a portion of tuition and related expenses for the person who paid them, whether that is the student's parent, spouse or themselves. The person's income must be below a given level that is adjusted each year and the student must be pursuing a degree or other recognized education credential. If claiming this credit, the person cannot also claim a Lifetime Learning Credit or Tuition and Fees tax deduction for the same student. This credit is now available for the first four years of a student's education.
The Lifetime Learning Tax Credit
This credit has a number of advantages over the American Opportunity Credit. Instead of just four years, it is available for an unlimited number of years. The student only need take one class and unlike the American Opportunity Credit, it does not need to be part of a degree program. There is still an income limit as there is with the American Opportunity credit.
Student Loan Interest Deduction
The interest paid on loans for higher education can be deducted from a person's income if their income is below a given level. The level can change every year, but in recent years has been $70,000 for a single filer and $145,000 for those filing a joint return. There is also a limit on the amount that one's income can be reduced by (typically about $2500).
Student Loan Cancellations and Repayment Assistance
In general, loan amounts that are forgiven are considered taxable income. There are exceptions for loans that are forgiven in return for the borrower working in a specific field for a specific number of years. Examples are loan forgiveness under certain teacher, public service, and lawyer programs.
Coverdell Education Savings Account (ESA) and 529 Plan (a.k.a. Qualified Tuition Plan)
These savings accounts are a way to save money for a child's college education. The advantage over regular savings is that the account'a earnings are tax deferred and withdrawals of proceeds for education purposes are also tax free. Many states also consider earnings on a 529 plan used for education purposes to be tax free.
Education Exception to Additional Tax on Early IRA Distributions
Normally, if the owner of an IRA takes a distribution before they are 59 years and six months old, they will have to pay a ten percent tax penalty on the amount withdrawn. However, if the money is used for higher education expenses for a family member including a grandchild, this penalty is waived.
Education Savings Bond Program
Under certain conditions, the interest earned on savings bonds may be excluded from income for tax purposes if used to pay for post-secondary education expenses for a family member or used to make a contribution to a 529 plan or a Coverdell ESA. There is an income limitation for this program.
Employer-Provided Educational Assistance
Educational assistance provided by an employer is tax-exempt up to a limit of about $5000, although this amount is subject to change. The employee should not see this amount included as part of their wages, tips or other compensation on the W-2 Form.
Tax Tips
- Married but Filing Separately has drawbacks - These filers are not eligible for Tuition & Fee Deductions, American Oportunity Tax Credits, Lifetime Learning Tax Credits and the Education Savings Bond program.
- No double-dipping - Multiple tax deductions or benefits cannot be taken for the same education expense.
- When in doubt, get help - Tax Advisors can help make the most of these education tax benefits.
Resources
IRS Publication 970: Tax Benefits for Education - Provides a detailed description of tax rules for education tax benefits.
IRS Tax Incentives for Higher Education website - Provides an overview of education credits and deductions.
Student Aid on the Web: Tax Incentives for Education - Gives an overview of education-related tax incentives.
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