Tax Benefits

The trend in the late 1990s has been to provide educational financing through tax breaks. Enrolled students and graduates should be particularly concerned with Employer Sponsored Tuition programs, Educational Expense Deduction (in lieu of the Lifetime Learning Credits) and the Student Loan Interest deduction.

IRS Publication 970, Tax Benefits for Higher Education is a great source for tax information regarding these programs. There have been several changes since 2001 as a result of the Tax Relief Act of 2001. This page serves as an introduction to the changes, but should not be considered legal advice.

The federal government provides a number of tax incentives that can help defray the cost of higher education. These incentives come in a couple of forms: Tax credits, which directly reduce the amount of tax you owe; and Tax deductions, which reduce the amount of income that you pay taxes on. You may qualify to use more than one of the benefits, but there are some restrictions against this as well. It's a good idea to figure your taxes multiple ways so you can get the maximum benefit available to you.

The American Opportunity Tax Credit was first made available in the 2009 tax year and is currently set to expire after the 2011 tax year. It offsets the cost of tuition, fees, course-related books, supplies, and equipment for higher education by reducing the amount of income tax you are liable for. In addition, the credit is partially refundable—meaning that you may be able to claim the tax credit and receive a check from the IRS even if you owe no income tax. The amount of the credit can be up to $2,500 per student. Up to $1000 of the credit can be refunded to you if your credit is more than the amount of tax you owe. You are eligible for the credit if your modified adjusted gross income is $90,000 or less (for married couples filing a joint return, $180,000 or less). The amount of the credit varies depending on income and how much you spent on higher education expenses, and how many eligible students are in your family. This credit is a temporary replacement for the Hope Credit which is not available for 2010. The American Opportunity Tax Credit has more generous benefits and is available to more taxpayers than the Hope Credit. It was enacted by the economic stimulus bill, the American Recovery and Reinvestment Act of 2009.

Expenses that count towards this credit are tuition, fees, course-related books, supplies, and equipment for higher education (less the amount of certain scholarships and grants received) during 2011 for yourself, your spouse, or someone you claim as a dependent on your tax return. Only expenses incurred for the first four years of undergraduate study count for purposes of this credit. The student must have been enrolled at least half-time for one term in 2011 in an eligible program leading to a degree, certificate, or other recognized credential at an eligible* school.
You must file a federal income tax return to get the credit (even if you are otherwise not required to file a return). If you are claimed as a dependent on someone’s tax return, only the person who claims you can apply for the credit. If you are not claimed as a dependent on someone else’s return, but were under age 24 at the end of 2011 and your earned income was less than one-half of your support, you can claim the credit to reduce any tax you owe, but are not eligible to get any refund. Students convicted of a felony for possessing or distributing a controlled substance are not eligible for the American Opportunity tax credit.

The Lifetime Learning Credit is available for all types of post secondary education, unlike the other credits. Use this credit once you have exhausted your eligibility for more advantageous credits. This credit may be particularly helpful to graduate students. You can claim a tax credit of up to $2,000 per tax return (not per student). The qualifying student(s) can be anyone in the family who appears on your tax return. The Lifetime Learning credit is non refundable— the maximum credit that you can receive is limited to the amount of tax you owe. You are eligible for the credit if your modified adjusted gross income is $60,000 or less (for married couples filing a joint return, $120,000 or less).

Expenses that count towards this credit are tuition, fees, and amounts required to be paid to the institution for books, supplies and equipment (less the amount of certain scholarships and grants received) during 2011 for yourself, your spouse, or someone you claim as a dependent on your tax return. You don't have to be pursuing a degree or certificate to qualify for the Lifetime Learning Credit. You can claim it for all years of post secondary education and for courses to acquire or improve job skills. You must file a federal income tax return and have a 2011 some income tax liability to get the credit. If you are claimed as a dependent on someone’s tax return, only the person who claims you can apply for the credit. If you claim the American Opportunity credit for one or more students in your family, you can't use their expenses to figure your Lifetime Learning Credit. You can still take a Lifetime Credit for family members for whom you are not claiming the other credits. Unlike other credits, students who have felony drug convictions do qualify to take the Lifetime Learning credit.

The Tuition and Fees Tax Deduction can reduce your taxable income by as much as $4,000. This deduction may be helpful to you if you are not eligible to take one of the tax credits. It is taken as an adjustment to income, which means you can claim this deduction even if you do not itemize deductions on Schedule A of Form 1040. You are eligible to take the deduction if your modified adjusted gross income is $80,000 or less ($160,000 if filing a joint
return). The amount of the Tuition and Fees Deduction you are eligible for depends on the amount of qualified tuition and related expenses paid for eligible students.

Expenses that you can deduct are tuition, fees, and amounts required to be paid to the institution for books, supplies and equipment (less the amount of certain scholarships and grants received) during 2011 for yourself, your spouse, or someone you claim as a dependent on your tax return. The expenses must have been for a student enrolled in one or more courses at an eligible educational institution. You can't claim both an education credit and the tuition and fees deduction for the same student for the same year, but you can take the deduction for one student and a credit for another. You can't take this deduction if you deduct tuition and fees expenses under any other provision of the law (for example, as a business expense). You can't claim this deduction if your filing status is married filing separately or if another person can claim you as a dependent on his or her tax return.

The Student Loan Interest Deduction can reduce your taxable income by as much as $2,500. It is taken as an adjustment to income, which means you can claim this deduction even if you do not itemize deductions on Schedule A of Form 1040. You can deduct interest paid on a student loan for yourself, your spouse, or your dependents. You are eligible to take the deduction if your modified adjusted gross income is $75,000 or less ($150,000 if filing a joint return). The amount of the Student Loan Interest Deduction you are eligible for depends on the amount of interest paid and your income.

Qualified student loans must have been used to fund educational expenses such as tuition, room and board, fees, and books for a student enrolled at least half-time and pursuing a degree, certificate, or similar program at an eligible institution. You cannot claim this deduction if your filing status is married filing separately or if another person can claim you as a dependent on his or her tax return.

For those who are planning their children's educations, there have been a number of improvements to the Section 529 plans and the Coverdell Education Savings Plan (formerly Education IRA). Withdrawals from 529 plans are not taxable, the contribution limits on the Coverdell Accounts have increased to $2,000 and Coverdell proceeds may be used for primary and secondary educational expenses.