For students and their parents, there are two tax credits that can help with the costs of higher education. The American opportunity tax credit is a partially refundable tax credit that you can receive for qualified educational spending. The lifetime learning tax credit is a non-refundable tax credit that you can receive based on tuition and fees for higher education. Depending on your status you may be eligible for one or both, and the IRS has an interactive tool to help you determine which. Here’s what you need to know.
A financial advisor can help you put a financial plan together to save up for your family’s education needs.
What Are Educational Tax Credits?
An education tax credit is a tax break that you can get based on educational spending. For every dollar in qualified spending, you can receive up to a dollar off your final tax bill. This is as opposed to a tax deduction, which reduces your taxable income, with the final reduction of your tax bill based on your tax bracket.
These educational tax credits apply to post-high school education, such as university and vocational schools, not K-12 spending.
As a student, you can claim educational tax credits so long as you are not claimed as a dependent on someone else’s taxes. If you are claimed as a dependent, then your parent or guardian may be able to claim any eligible educational tax credits.
The IRS offers two educational tax credits: The American opportunity tax credit (the AOTC) and the lifetime learning credit (the LLC).
The American Opportunity Tax Credit
The American opportunity tax credit is a partially refundable tax credit for qualified education expenses. Eligible taxpayers can receive an annual credit of up to $2,500. If the full credit brings your tax bill below zero, you can potentially get a refund worth up to 40% of your remaining credit for a maximum of $1,000. For example, say that your tax bill is zero and you have an AOTC worth $1,200. You could receive a $480 refund ($1,200 * 0.4).
That American opportunity tax credit applies to 100% of the first $2,000 in qualified spending. Then, you can claim an additional 25% of any additional spending up to $2,000. For example, say that you spend $3,000 on books and equipment. You could claim $2,250 under the AOTC (1.0 * $2,000 + 0.25 * $1,000).
You can claim the AOTC for qualified educational expenses. The IRS defines this as money that you pay for tuition, fees, books, supplies, equipment and any other expenses required for enrollment or attendance. For the purposes of this tax credit, you do not have to pay these expenses directly to the institution so long as they constitute required spending. For example, required textbooks purchased from an off-campus bookstore are claimable expenses under this credit.
You (or your dependent) must be enrolled in a degree- or credential-granting program at a qualified educational institution, and must be enrolled at least half time during the tax year for which you are claiming the credit. You can only claim it for up to four tax years (even if the student is in school longer), although they do not have to be consecutive, and only students still in their first four years of higher education are eligible.
Finally, your modified gross adjusted income must be no more than $80,000/$160,000 single/married filing jointly. You can receive a partial credit if your MAGI is up to $90,000/$180,000 single/married filing jointly, after which you cannot claim this credit.
The Lifetime Learning Tax Credit
The lifetime learning credit (the LLC) is a nonrefundable tax credit worth up to $2,000. If your tax bill hits below zero you cannot receive any money back from this credit.
You can only claim the lifetime learning tax credit for tuition or other required enrollment fees. It does not apply to other costs of attendance such as books or equipment. However, unlike with the AOTC, you do not need to be enrolled in a degree-seeking program to claim the lifetime learning credit. You must be taking courses at a qualified educational institution, which can include universities and vocational programs. You must also be enrolled in one or more courses for the year in which you claim the tax credit. However you do not need to be pursuing a formal credential.
You can claim the LLC for the 20% of the first $10,000 you spend, up to a maximum of $2,000, on your eligible tuition and fees. You can also claim it any number of times. This credit does not fall off after a certain number of years.
The lifetime learning tax credit has the same income cutoffs as the American opportunity tax credit. You can claim the full credit up to an MAGI of $80,000/$160,000 single/married filing jointly. You can receive a partial credit up to $90,000/$180,000 single/married filing jointly, after which you cannot claim this credit.
Additional Benefits and Deductions
Beyond tax credits, you can find a network of resources to help you prepare and pay for a college education. These options include:
529 Savings Plans
A 529 plan is a tax-advantaged account that you can use to save for the costs of education. These are operated at a state-level, so your options will vary based on your specific jurisdiction. While contributions to a 529 plan are not tax deductible for federal tax purposes, the funds in these plans can typically grow either tax-free or tax-deferred. Depending on the nature of your plan and your spending, you might also be able to make withdrawals tax-free.
A 529 plan is typically either structured as a general educational savings fund or as a prepaid tuition fund.
Student Loan Interest Deductions
Most people who hold student loans can take advantage of the student loan interest deduction. This is an above-the-line tax deduction that you can take for up to $2,500 worth of student loan interest payments each year.
State-Level Deductions
Many states offer deductions to your state taxes based on qualified education spending. For example, in Massachusetts you may be able to take a tax deduction based on tuition payments that you make to a qualified two- or four-year college or university. Not every state offers education deductions, but if you live in an income tax state make sure to look this up.
Education Savings Bonds
The education savings bond program allows you to collect interest on U.S. savings bonds tax-free when you spend that money on qualified educational expenses. This isn’t a blanket grant, it has both income and spending requirements, but it can make Treasury investments a tax-advantaged way to save for college.
Bottom Line
There are several tax benefits available if you pay tuition or other costs associated with higher education. On the federal front, you may be able to take advantage of the Lifetime Learning and American Opportunity tax credits, or enjoy the tax benefits of Education Savings Bonds. From there, depending on where you live, your state may offer a variety of programs and deductions.
Tuition Spending Tips
- A four-year degree is still the best investment you can make in your, or your child’s, future. It has gotten incredibly expensive, though, so let’s take a look at strategies you can use to prepare for that spending.
- A financial advisor can help you build a financial plan for your education needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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