Tax Benefits of Higher Education
Are there any tax benefits associated with my children’s higher education?
Yes, there are three types of benefits available; the American Opportunity Credit, the Lifetime Learning Credit and the Tuition and Fees Deduction. Contact us for more information concerning the Tax Benefits of Higher Education.
What is the American Opportunity Credit?
The American Opportunity Credit is a credit of up to $2,500 for qualified education expenses per eligible student for amounts paid on behalf of your dependent, yourself or your spouse. It is available for the first four years of education in pursuing a bachelor’s degree or other recognized education credential. Expenses which qualify for the credit include tuition and fees paid directly to the institution and course related books, supplies and equipment which can be purchased anywhere. The student must be enrolled at least half time for one semester.
A dependent on someone else’s return may not claim the credit. Room and Board and other living expenses do not qualify for the credit.
The credit begins phasing out when your modified adjusted gross income reaches $90,000 ($180,000 if married filing joint). For most taxpayers whose income does not exceed the phase out limitations, forty percent of the credit will be refundable.
Qualified tuition expenses paid on behalf of the student by someone other than the student or the person who can claim the exemption for the student as a dependent are eligible for the credit by the person who can claim the exemption for the student.
Students who have a felony drug conviction on their record are not eligible students.
Do any tax planning considerations apply to the education tax credit?
The American Opportunity Credit phases out at a modified adjusted gross income (MAGI) of $90,000 ($180,000 if married filing joint). If it is possible and prudent, a taxpayer should defer income to subsequent years if their MAGI reaches the phase out threshold in order to qualify for the credit.
Are living expenses while attending school included in qualified tuition expenses?
Living expenses are not included in qualified tuition expenses even if they are required and paid to the institution. Although, funds distributed from a 529 plan can be used to pay for room and board.
Is there a tax deduction for higher education expenses?
Yes, a deduction of up to $4,000 is available for amounts paid for qualified education expenses on behalf of you, your dependent or your spouse. The deduction begins to phase out when your modified adjusted gross income reaches $65,000 ($130,000 if married filing joint). This deduction is commonly referred to as the Tuition and Fees Deduction.
Expenses which qualify for the Lifetime Learning Credit include tuition and fees for undergraduate or graduate credit which must be paid directly to the institution in order to attend classes.
If expenses are paid by someone else and no one can claim an exemption for the student then the student may take the deduction for expenses paid. If you can claim an exemption for the student and the expenses are paid by someone other than you no one can claim the deduction.
Are there any benefits available for continuing/adult education expenses?
Yes, a Lifetime Learning credit of up to $2,000 is available for qualified education expenses paid on behalf of you, your dependent or your spouse. There is no limit on the number of years you can claim this credit. The Lifetime Learning credit begins to phase out when your Modified Adjusted Gross Income reaches $50,000 (100,000 for married filing joint).
Expenses which qualify for the credit include tuition and fees for undergraduate or graduate credit and classes to acquire or improve job skills which must be paid directly to the institution in order to attend classes.
Expenses paid by or on-behalf of your dependent will be treated as paid by you for purposes of calculating the credit.
Is the interest I pay on my student loans deductible?
Yes, a deduction of up to $2,500 of student loan interest is allowed for the tax year in which it was paid. For the interest to be deductible it must be on a qualified student loan that you are obligated to make payments on. A qualified student loan is a loan in which the proceeds were used to pay qualified education expenses to an eligible educational institution on behalf of yourself, your spouse or a dependent during an academic period when the student was enrolled at least half-time. In addition, you could not have been claimed as a dependent by any other taxpayer and your filing status cannot be married filing separate to take the deduction. The student loan interest deduction begins to phase out when your modified adjusted gross income reaches $60,000 ($120,000 for married filing joint).
Qualified Education Expenses for the purposes of the student loan interest deduction calculation include tuition, fees, room and board, books, supplies, equipment and other necessary expenditures such as transportation.
If I use a home equity loan to pay qualified higher education expenses is the interest deductible?
Yes, the applicable portion of a home equity loan interest which was used to pay higher education expenses may be deducted as student loan interest subject to the same phase out rules as any other type of qualified student loan.
Can I pay my qualified education expenses from my traditional IRA?
Distributions used to pay qualified education expenses are exempt from the 10% premature distribution penalty.
Can I pay my qualified education expenses from my Roth IRA?
Distributions used to pay qualified education expenses are exempt from the 10% premature distribution penalty.
What is a Coverdell (Section 530) Account?
A Coverdell Education Savings Account is a trust or custodial account established exclusively to save and pay for a beneficiary’s qualified education expenses. Contributions are limited to $2,000 per beneficiary and cannot be made after the beneficiary turns 18. The $2,000 contribution limit is subject to a phase out between $95,000 and $110,000 for single taxpayers and between $190,000 and $220,000 for joint filers in 2010.
What are some of the differences between a Coverdell Education Savings Account (CESA) and Qualified Tuition Programs (QTPs)?
- QTPs annual contributions are not limited.
- CESA annual contributions are limited to $2,000 and are subject to phase out rules.
- QTPs can only be used for qualified higher education expenses.
- CESA distributions can be used for elementary and secondary education expenses as well as higher education expenses.
What is a 529 plan?
A 529 plan is a tax-advantaged savings plan specifically designed to encourage saving for future college costs. These plans, which are also known as “qualified tuition plans”, are sponsored by states, state agencies, or educational institutions. There are two different types of 529 plans: pre-paid tuition plans and college savings plans. Below is a chart that lists out the major differences between these two types of 529 plans. For detailed information on Virginia 529 plans visit: http://www.virginia529.com
| Prepaid Tuition Plan | College Savings Plan |
| Locks in tuition prices at eligible public and private colleges and universities. | No lock on college costs. |
| All plans cover tuition and mandatory fees only. Some plans allow you to purchase a room & board option or use excess tuition credits for other qualified expenses. | Covers all “qualified higher education expenses,” including:
|
| Most plans set lump sum and installment payments prior to purchase based on age of beneficiary and number of years of college tuition purchased. | Many plans have contribution limits in excess of $200,000. |
| Many state plans guaranteed or backed by state. | No state guarantee. Most investment options are subject to market risk. Your investment may make no profit or even decline in value. |
| Most plans have age/grade limit for beneficiary. | No age limits. Open to adults and children. |
| Most state plans require either owner or beneficiary of plan to be a state resident. | No residency requirement. However, nonresidents may only be able to purchase some plans through financial advisers or brokers. |
| Most plans have limited enrollment period. | Enrollment open all year. |
1 Source: Smart Saving for College, FINRA®
How do I know if I am eligible for an education tax credit?
The IRS website has a tool that is designed for use by taxpayers that were U.S. citizens or resident aliens for the entire tax year to determine whether or not they are eligible to claim an education credit. This tool will help you determine if you are eligible for certain education credits and/or deductions including the American Opportunity Credit, the Lifetime Learning Credit, and the Tuition and Fees Deduction. Click here to find out if you are eligible to claim an education credit.