Whether you’re a student or a parent, you know that tuition, the fees and the supplies are all skyrocketing.
Any relief from paying it all is most welcome. This detailed Q&A will provide you knowledge and insight on some potential credits and deductions you can possibly take advantage of.
Q: What is an educational tax credit and who qualifies?
An educational tax credit lowers the amount of tax you owe on your annual tax return and helps cover some of the cost of higher education. This credit can overall ease the cost of tuition you owe by decreasing the amount owed on a tax return— and if the credit lowers the bill to below zero, a refund can be given in the form of cash to use on any educational expenditures.
There are two educational tax credits available including the American opportunity tax credit (AOTC) and the lifetime learning credit (LLC) but it’s important to meet all three of the following requirements:
- You, your spouse or your dependent is an eligible student who is enrolled at an eligible educational university and listed in your tax return
- You, your dependent or a third party helps pay certain educational expenses for higher education
Q: What is the difference between a tax duction and a tax credit on tuition?
Simply put, a tax deduction reduces a person’s taxable income whereas a tax credit directly lowers the amount of tax a person owes. A tax credit is therefore a reduction that is a dollar amount and can be both nonrefundable and refundable. A nonrefundable credit can bring your tax liability to a zero while a refundable credit can do the same with an additional advantage of earning back a refund of the balance of the credit that’s leftover if you do reduce your tax to zero.
Tax deduction, to this end, has the power to lower a person’s tax liability. It can, like a tax credit, lower the amount of tax a person owes but not by directly decreasing the tax amount someone owes, like the credit. How advantageous a tax deduction is depends on a person’s tax rate. It’s best to speak with a tax professional about which works better for you, if eligible.
Q: How can a parent or student take advantage of deductions like the American Opportunity Tax Credit or the Lifetime Learning Credit if paying for tuition?
Deductions can easily be taken advantage of when paying for a child’s school and help decrease the cost of tuition fees or textbooks or other resources paid to a qualified educational organization. For example, the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit are able to decrease your tax liability to as low as $2,500 or $2,000. The AOTC can be claimed during the first four years of a higher education and if the credit lowers your tax owed to zero, you are eligible for up to 40% of the remaining amount that is refunded to you (1,000 dollars maximum). It works by giving you 100% credit of the first 2,000 dollars spent on educational expenses and 25% of the next 2,000.
Different from the AOTC, the Lifetime Learning Credit has no limit on the amount of years you or your dependent goes to school. To this end, it can help pay for various degrees and works like this: you get 20% credit on the first $10,000 spent on qualified expenses or up to 2,000 per tax return. Important to note, the Lifetime Learning Credit is not refundable even if the tax bill is lowered to zero.
Please note: Many times the parents will phase out of this credit due to income limitations. It may be better for the student to pay the tuition so that they can take full advantage of this credit. Discuss with your tax preparer!
Q: What are certain tax deductions for interest payments on student loans, the income limitations and the requirements for the deduction?
There is a tax break called the student loan interest deduction and it is a federal income tax deduction that relieves any borrower of $2,500 from their taxable income on the interest paid for student loans. This deduction can be found directly on form 1040 and for those who pay more than $600 on interest a year and fall within the 22% tax bracket should be sent a Form 1098-E from the institution itself.
The IRS specifically states the different tax deductions available for students or parents to lower their annual taxable income. The requirements to use a student loan deduction include:
- The student loan has to be meant for the taxpayer, the spouse or a dependent and the school they go to has to be an eligible institution
- The student loan has to be used for academic expenses like tuition, fees, or approved resources— not for items like housing or insurance
- The student loan has to be applied for an academic period that the student is either fully or part-time enrolled in. It also has to be for an institution that will then award a degree, certificate or other certified credential.
- The student loan has to be used within 90 days before or after the academic period begins or ends.
Please note that the federal loan borrowers currently have their deductions to claim as payments for interest on hold, as they were suspended by President Joe Biden through August 31, 2022 and may continue to be in the future.
Q: Can you deduct college tuition on your federal income taxes?
Yes, there are several ways you can deduct college tuition on your federal income taxes. You can either use the AOTC, the Lifetime Learning Tax Credit, the Tuition and Fees Deduction or the Employer-Paid Educational Assistance, or the tax-free distributions taken from a college savings. The Tuition and Fees deduction can exclude up to $4,000 in tuition and fees and the income phaseouts are $65,000 to $80,000 for single taxpayers and $130,000 to $160,000 for those married that are filing together.
The Employer-Paid Educational Assistance can provide up to $5,250 in employer paid educational assistance and can be excluded from your income and this tax benefit is able to be used for as many years as needed. The student has to be the employee and there are no income phaseouts.
We have explained the AOTC and the Lifetime Learning Tax Credit in question three.
Q: What form should I use when reporting qualified educational expenses?
When reporting qualified educational expenses that are paid for, use the form 1098-T. It is a form that the higher education institution uses in order to report the expenses to both you and the IRS. These reported expenses are the very ones you can claim as tax credits.
Sounds daunting? Still have questions? We’re Here to Help!
Managing taxes when the season rolls around is never easy and Jeanine Hemingway, CPA can help. You might be missing out on opportunities to offset tuition expenses if you aren’t seizing the tax deductions and credits available to you.
Talk with us today about how we can navigate your tax bills to best suit your higher education needs— you just might have some money coming back into your pocket!