College Tax Credits Can Ease Costs of Higher Education by Joanie B. Stein, CPA
Posted on January 19, 2021
A college education is a significant expense. To help reduce the financial burden of paying for higher education, college students and their families may qualify for certain tax credits and other tax-advantaged savings programs offered through public and private sources.
The American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) provides a maximum annual credit of $2,500 for the qualified education expenses paid for part-time or full-time students pursuing a college or other recognized higher-education degree. The credit equals 100 percent of the first $2,000 and 25 percent of the next $2,000 paid for each student’s eligible expenses, which can include tuition, activity fees, books and other supplies students require to complete coursework. Additionally, because 40 percent of the AOTC is refundable, you may receive a refund from the federal government of up to $1,000 if the credit brings your tax bill down to zero.
To qualify for the AOTC in tax years 2020 and 2021, modified adjusted gross income (MAGI) must not exceed $80,000 for individuals and $160,000 for joint tax filers. A partial credit is available when MAGI is between $81,000 and $90,000 for individual filers, and $161,000 and $180,00 for married couples filing jointly. Claiming the credit requires you to submit IRS Form 8863, Education Credits, with your annual tax return. To do so, you will need to include information from IRS Form 1098-T, Tuition Statement, which colleges and universities make available to students in in late January.
Parents with income above the MAGI thresholds, who would otherwise not qualify for the credit despite paying for their children’s higher education costs, may instead shift the benefit of the AOTC to their qualifying children by not claiming those children as dependents on the parents’ tax returns. This is especially advantageous to children with sufficient taxable income who can yield the full $2,500 of the AOTC rather than providing the high-earning parents with a $500 dependent credit. However, before deciding whether or not to claim your college-age child as a dependent, check the requirements of your family’s health insurance plan, since some policies require children older than 26 to be claimed as dependents on their parents’ tax returns as a condition of insurance coverage.
Lifetime Learning Credit
The Lifetime Learning Credit (LLC) provides a credit of up to $2,000 per year for qualified tuition and higher-education expenses, including individual courses and programs you pay to maintain and improve job skills. It is computed as 20 percent of eligible expenses totaling $10,000 or more. While there is no limit to the number of years you can claim the LLC, you may not receive the benefits of the LLC for the same student or expenses that received an American Opportunity Tax Credit in a particular year.
Unlike the AOTC, the Lifetime Learning Credit does not benefit individuals who owe no taxes. However, it does offer lower income limit qualifications. Specifically, qualifying for the full LLC credit requires MAGI be less than $59,000 for individuals and $119,000 for married couples filing joint tax returns. A partial credit is available when MAGI is below $69,000 for individuals, or $139,000 for married filing jointly. Like the AOTC, claiming the LLC credit requires you to use the information on IRS Form 1098-T, Tuition Statement, to file Form 8863, Education Credits, with your annual tax returns.
Tax Benefits of Scholarships, Loans and College Savings Programs
Scholarships that pay for student tuition, enrollment fees, books and other required course materials are tax-free, unlike those grants that pay for room and board, which are taxable. If you take out a loan to pay for qualifying education expenses, you may be able to deduct up to $2,500 in loan interest from your taxable income.
Finally, saving or prepaying for college through a state- or college-sponsored 529 plan allows contributions to grow tax-free. Distributions to pay for qualifying expenses, including room and board, are also tax-free to students. However, contributions to 529 plans may not exceed the amount necessary to provide for the beneficiary’s qualified education expenses.
Understanding the various tax credits, deduction and savings plans and their limitations can make higher education more affordable. The Tax Services professionals with Berkowitz Pollack Brant work with individuals and families to develop efficient tax-planning strategies that identify tax-savings opportunities and meet each family’s unique financial needs.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely-held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.