Tax Breaks for Higher Education

January 2014

Without a doubt, paying for a college education has become one of the biggest headaches for students pursuing degrees, and their families. Fortunately, the federal government offers several tax credits and deductions that can turn college spending into a little extra relief at tax time.

In this article, we will take a quick rundown of the education-related tax breaks that you may be able to take advantage of this filing season and also point out which tax forms to look for to make sure you reap the benefit from them.

American Opportunity Credit

The American Opportunity Credit allows you to take a credit for up to $2,500 of qualified education expenses. Look for Form 1098-T from your college or university which reports the amount of tuition billed by the institution for the year. Please keep in mind, this credit can only be used for up to 4 years so it’s best to make the most of it while you can! Forty percent of the credit (i.e. up to $1,000) is refundable; what that means is that even if you owe no taxes, you may still qualify to receive a “refund.” A key consideration is that you must be enrolled at least half time for at least one academic period during the course of the year. The full credit generally is available to eligible taxpayers whose modified adjusted gross income (MAGI) is below $80,000 ($160,000 for married couples filing a joint return).

Lifetime Learning Credit

This education tax credit will give you up to $2,000 in credit for education-related expenses for an unlimited number of years. You don’t even have to be pursuing a degree for this credit to apply; however, if you’re not, the courses must help you to acquire or improve job skills. Keep in mind though that this credit is not refundable and therefore can only be used to offset an existing tax liability. For 2013, the amount of your lifetime learning credit is gradually reduced (phased out) if your MAGI is between $53,000 and $63,000 ($107,000 and $127,000 if you file a joint return). Also note that you cannot take both the Lifetime Learning and American Opportunity Credit for the same student in the same year – Choose wisely!

BNN Tax Tip: Take the $2,500 American opportunity credit for the maximum 4 years if you qualify and then start using the $2,000 Lifetime Learning Credit for subsequent years. Also, the Lifetime Learning Credit may be particularly helpful to graduate students who are only taking one course or for those who are not pursuing a degree.

Tuition and Fees Deduction

This benefit allows you to deduct up to $4,000 of qualified education expenses, which includes tuition, books, and mandatory fees. A key consideration is that room and board is not a qualifying expense. Fortunately, you can take this deduction even if you don’t “itemize” your deductions, which means that this deduction is available to almost everyone. Generally, you can claim the tuition and fees deduction for qualified higher education expenses for an eligible student if your modified adjusted gross income is below $80,000 ($160,000 if married filing jointly).

Student Loan Interest Deduction

The interest on your student loans is deductible and can reduce your taxable income by up to $2,500. Look for Form 1098-E from your lender if you paid more than $600 in interest. Do consider that only the interest is deductible and not the total payment. Similar to the Tuition and Fees deduction, this deduction is available even if you don’t itemize. For 2013, you can claim this deduction if your MAGI is $75,000 or less ($155,000 or less if you file a joint return).

Don’t have children in college yet but want to start saving for the upcoming assault that college will make on your finances?

§529 College Savings Plan

Most states sponsor §529 plans that allow parents to either prepay or contribute to an account for paying a student’s qualified higher education expenses. Those interested in using tax sheltered accounts for education should consider contributing to a §529 college savings plan. Income earned in the account and distributions from the plan are designed to be tax-free assuming they are used for college-related expenses for the designated beneficiary.

State Tax Considerations for Maine Residents:

Contributions to Maine and non-Maine §529 plans of up to $250 per beneficiary per year are deductible in computing Maine taxable income for taxpayers with federal adjusted gross income of $100,000 or less (single or married filing separate) or $200,000 or less (married filing jointly).

Conclusion

If you or your dependent is a student, you should invest the time required to determine whether you are eligible for any of these tax benefits and, if eligible, what benefit will yield the greatest tax savings for you or your family. Note that many of these tax benefits are available to students or the parents of students, and the child’s status as a dependent may determine who claims the benefit. Deciding how to best utilize dependency exemptions can be complex.  Therefore, you may want to consult a tax advisor to make sure you have considered all the options available and have maximized the collective benefits. Generally speaking, education credits will provide greater tax savings than a tuition deduction since they reduce your tax bill on a dollar-for-dollar basis. Saving dollars on your taxes may turn out to be well worth the time!  More in-depth information regarding tax benefits for education can be found here.

If you would like to discuss further, please call your BNN advisor at 1-800-244-7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.