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Both college students and their parents or guardians worry about ways to pay college tuition without crippling student debt. Indeed, the rising cost of higher education in the United States is cause for concern!
Fortunately, there are many tax breaks for college students (education tax breaks) that decrease the total cost of tuition and fees, textbooks and supplies, and on-campus room and board – collectively known as the cost of attendance (COA) – for college students and their parents and guardians.
According to Education Data, the average COA at a public four-year institution ranges between $25,707 (in-state students) and $44,014 (out-of-state students) per year. The average COA at private nonprofit universities is even higher at $54,501 per year.
However, it isn’t just college tuition and fees that students must be concerned about. College education also comes with related out-of-pocket costs like daily living expenses, transportation expenses, and student loan interest. The student loan interest can be onerous, too, with student borrowers paying $2,186 per year, on average.
College students and their parents/guardians get a break from these higher education expenses, thanks to the college tax credits, deductions, and savings accounts offered by the federal government.
Many of these tax breaks are administered by the Internal Revenue Service (IRS), and these tax benefits can be used to recoup part of the money spent on college tuition or on student loan interest payments, even in maximizing college savings.
These education tax breaks can be complicated with many tax laws, and their implementing rules and regulations change every year! Here’s a quick guide about tax credits and deductions, qualified higher education expenses, and other aspects of tax benefits for college students to simplify the matter.
Education Tax Credits
College tax credits are the best tax breaks that college students and their parents/guardians can take advantage of! These tax credits directly apply toward the amount of income tax you owe instead of decreasing your taxable income on your tax return.
If an education tax credit decreases your income tax to less than zero, there’s a possibility of a refund.
Types of Education Tax Credits
The federal government offers two types of education tax credits:
- American Opportunity Tax Credit (AOTC), and
- Lifetime Learning Credit (LLC)
Note that you can claim both college tax credits (i.e., only one education tax credit is allowed for claiming).
Both tax breaks, however, require the completion of Form 8863 and Form 1098-T, which show the amount of tuition paid and the qualified expenses made for that year.
American Opportunity Tax Credit
Of these tax breaks, the American Opportunity Tax Credit is arguably the most popular because of its higher maximum annual credit and refundable nature. The tax credit applies to qualified education expenses that have been paid for by an eligible student for the first four years in college.
The current maximum annual credit is $2,500 for every eligible student. In case the tax credit brings the income tax to zero, up to 40% of the remaining amount of the credit can be refunded to the taxpayer; there’s a $1,000 limit on refunds. Qualified education expenses for every eligible student must be declared to avail of the tax credit.
To become an eligible student for the American Opportunity Tax Credit, a student must:
- Be pursuing a degree, a certificate, or a recognized educational credential in an eligible educational institution;
- Have half-time enrollment in at least one academic period starting in the tax year
- Not have completed the first four years of college at the start of the tax year
- Not have claimed either the American Opportunity Tax Credit or its predecessor, the Hope tax credit, for over four tax years
- Not hold a felony drug conviction at the end of the tax year
Claiming the full American Opportunity Tax Credit comes with income limits, with the current rules being:
- Your modified adjusted gross income must be equal to or less than $80,000; married taxpayers filing jointly have a $160,000 or less income limit
- Your tax credit will be decreased if your modified adjusted gross income is more than $80,000 but less than $90,000; in the case of married taxpayers with a joint income tax return, the range is more than $160,000 but less than $180,000.
- You’re not allowed to claim the credit if your MAGI or Modified Adjusted Gross Income is in excess of $90,000; joint filers have an income limit of $180,000
The MAGI refers to the adjusted gross income as shown on the tax return.
While the American Opportunity Tax Credit is among the best education tax benefits, it carries stiff penalties for misrepresentation and other mistakes made in its claim. The IRS may require paying back the amount – principal and interest – from the tax credit, charging a fraud and/or accuracy penalty, and/or imposing a 2-10 year on claiming the tax break.
Lifetime Learning Credit
Yet another tax credit that applies to tuition and fees and related expenses paid for an eligible student in an eligible educational institution is the Lifetime Learning Credit. This is similar to the American Opportunity Tax Credit but has less restrictive rules.
First, the Lifetime Learning Credit doesn’t have a limit on the number of years that it can be claimed – you can claim the credit for as long as you’re qualified.
Second, the tax credit does not require an eligible student to pursue a degree or be enrolled at least half-time. This tax credit is then suitable for taxpayers who are pursuing undergraduate and graduate degrees, as well as career development courses (i.e., not a recognized educational credential).
However, the tax credit is non-refundable, meaning there are no refunds, unlike the American Opportunity Tax Credit. The maximum tax credit is also lower at $2,000 per tax return – the equivalent of 20% of $10,000 of eligible expenses incurred while enrolled in an eligible educational institution. The qualified educational expenses include eligible tuition and fees and other related expenses.
The Lifetime Learning Credit may be claimed if:
- You, the taxpayer, your dependent, or a third party pay for the eligible education expenses
- You, the taxpayer, your dependent, or a third party pay the qualified education expenses for an eligible student
- You, or your spouse, or your dependent is the eligible student and must be listed on your tax return
You cannot claim the credit, however, in the following instances:
- Your parents or other taxpayers have already listed you as a dependent
- You’re a married individual who files a separate tax return from your spouse (i.e., married filing separately)
- You have already deducted another college tax credit using the same expenses or the same student
There are income limits, too, for the Lifetime Learning Credit, but these are the same as for the American Opportunity Tax Credit, including for joint filers. Note that joint filers with modified adjusted gross income of $180,000 and above are ineligible; it’s $90,000 for single filers.
Tax Deductions for College Students
We have to say that tax deductions for college students aren’t as valuable as the abovementioned tax breaks, but these are still worthy of your time!
Tax deductions decrease the amount of tax you’re required to pay by decreasing your taxable income (i.e., the amount of income subject to tax). With a lower modified adjusted gross income, you’re also more likely to be qualified for other tax credits and deductions.
Types of Tax Deductions for College Students
Just as with tax credits, tax deductions for college education are covered by rules and regulations that taxpayers must be aware of.
Student Loan Interest Deduction
The first and foremost tax deduction for a college education is the student loan interest deduction. The special deduction is only allowed on interest paid on a student loan or an education loan used to pay for college tuition and qualified education expenses. The eligible student loan interest covers both the compulsory and voluntary interest payments made during the year.
The student loan interest deduction is a special deduction because personal interest paid on loans is, in general, not deductible on a tax return. The few exceptions include certain mortgage interest payments.
Note, too, that the student loan interest deduction is considered an adjustment to income, meaning you can claim the tax break even if itemized deductions aren’t made (i.e., above-line adjustment to income) on Schedule A of Form 1040.
The student loan interest deduction can decrease the amount of income subject to tax by as much as $2,500 (i.e., maximum limit) per year. The adjusted gross income, as reflected on the income tax return, is before the deduction for the student loan interest is made.
The student loan interest deduction may be claimed upon meeting all these requirements:
- You made an interest payment on an eligible student loan in the tax year you’re filing for
- You have a legal obligation to pay the student loan interest
- Your taxpayer filing status is not “married filing separately.”
- Your MAGI or Modified Adjusted Gross Income is less than the specified amount set every year (Couples filing jointly with income above $175,000 and single filers with income above $85,000 in 2022 aren’t qualified for the tax deduction. Income phaseouts are also in effect. Eligibility for the tax deduction may also be decreased if your employer made student loan interest payments as a work-related benefit)
- You and your spouse, when filing jointly, are declared or claimed as dependents on another taxpayer’s tax return.
Tuition and Fees Deduction
Sadly, tuition and fees deduction has been repealed starting in 2021 through the Taxpayer Certainty and Disaster Tax Relief Act of 2020. The education tax deduction is then unavailable in 2022 and beyond.
To better understand the abovementioned terms, here are a few brief explanations.
Qualified Student Loans
These are loans that have been incurred with the express and exclusive intention of paying for qualified education expenses. These loans can be incurred in your interest, for your spouse, or for your dependent at the time of the loan.
Note that loans from a related person or an eligible employer plan aren’t considered qualified student loans.
Qualified Education Expenses
These include tuition and fees, books, supplies and equipment, and room and board. There are limitations to the room and board as qualified education expenses – the cost qualifies only up to the extent that it isn’t more than the greater of either the actual amount paid for residential housing owners or operated by the university or the allowance for room and board set by the university.
College Savings Accounts
Aside from the college tax credits and deductions mentioned above, college students and their parents/guardians can take advantage of other methods for decreasing the costs of higher education.
Coverdell Education Savings Account
The Coverdell Education Savings Account (ESA) can be used to pay for specific higher education expenses; it’s also applicable for K-12 education expenses.
As of late, you can establish as many Coverdell ESA accounts for a particular beneficiary, but the total contributions made in any year for all accounts for said beneficiary has a $2,000 limit. An eligible beneficiary is an individual under 18 years old or with special needs.
Coverdell ESA contributions aren’t tax deductible, but the contributed amounts earn income without being subjected to tax until it is distributed. However, the specified beneficiary will not have a tax obligation on the distribution if and when it is less than their qualified education expenses. Qualified distributions include tuition and fees, required supplies, equipment and books, and room and board.
In case of the distribution exceeding eligible education expenses, a tax bill will be imposed, usually an additional 10% tax. There are exceptions to the additional tax, including the beneficiary being awarded a qualified scholarship or in the event of disability or death.
529 Plan
States and schools can establish a 529 Plan, which are programs that enable parents/guardians to make contributions in anticipation of payments for qualified expenses for their dependents’ college education (i.e., prepayments).
Note that contributions and/or payments to a 529 Plan aren’t deductible, but money withdrawn from the 529 Plan isn’t taxable. The specified beneficiary/college student can also secure a tuition waiver thanks to prior contributions made.
However, a tax will be imposed when the distributed amount is higher than the adjusted eligible education expenses. The qualified costs include compulsory tuition and fees, supplies, equipment including computer setups (i.e., hardware, software, and Internet access), and books. For half-time college students, room and board may also be considered qualified education expenses.
Education Savings Bonds
Education savings bonds become exempt from tax when their owners/bearers use the principal and its interest income to pay for higher education expenses. These funds can be used by the owners/bearers themselves, their spouses, or their dependents. All or some of the interest income may be exempted from tax.
Other tax benefits that can be used to defray college costs are IRA withdrawals and educator expense deductions. If you withdraw from an IRA for college costs for yourself, your spouse, or your child or grandchild, you won’t have to pay the early withdrawal penalty, but you will still get a tax bill for the federal income tax.
In conclusion, the tax laws on tax credits and deductions for college students are ever-changing and complicated. While there are plenty of official websites of concerned government agencies and how-to guides online, when in doubt, always seek the professional opinion of a tax professional like a CPA, or Certified Public Accountant, or Tax Attorney.
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