Tax Savings Opportunities for Education Expenses
An overview of the various tax credits, deductions and other incentives available for pursuing post-secondary education…
The value of higher education to an individual’s career and standard of living is widely recognized. One of the best ways to increase the affordability of postsecondary education for you, your spouse or dependents is to take advantage of federal tax incentives. This article discusses the deductions and credits, as well as taxable income exclusions, which may be available to help offset education expenses.
Deductions and Credits
Several tax deductions and credits are available for educational expenses. Tax credits differ from deductions in that credits directly reduce the amount of income tax you may have to pay, while a deduction reduces the amount of income subject to tax. The IRS makes the following deductions and credits available for education benefits:
- American Opportunity Credit. The American Opportunity Credit allows taxpayers to claim up to $2,500 of qualified postsecondary education expenses as a credit. Tuition, books, supplies and equipment, and required fees are eligible expenses for this credit. Eligible students must be attending a degree program at least half-time during their first four years of college. The credit is a "per student credit," meaning you may claim the full amount of the credit for any number of eligible students in a tax year. If your credit exceeds the amount you owe, up to 40 percent ($1,000) is refundable. The American Opportunity Credit is allowable for four years of postsecondary education. However, if your 2015 modified adjusted gross income (MAGI) is over $90,000 ($180,000 for married filing jointly), you cannot claim the credit. The American Opportunity Credit expires December 31, 2017, and will revert back to the Hope Scholarship Tax Credit, which will decrease the maximum credit available, unless changed by Congress.
- Lifetime Learning Credit. The Lifetime Learning Credit applies to expenses paid for qualified postsecondary education and for courses to acquire or improve job skills. The amount of the lifetime learning credit is 20 percent of qualified amounts paid, up to $2,000. There is no maximum number of years the credit can be claimed. The credit is not refundable, which means it can reduce your tax to zero, but if the credit is more than your tax due, the excess will not be refunded. You cannot claim the credit if your 2015 MAGI is over $65,000 ($130,000 for married filing jointly). Note: the American Opportunity Credit and the Lifetime Learning Credit cannot be claimed for the same student in the same year.
- Deduction for Student-Loan Interest. If you paid qualified student-loan interest on a loan taken out for educational expenses for you or your dependent (or a student who was your dependent when you took out the loan), you may be able to claim a deduction up to $2,500. There is no time limit on the deduction—you can deduct interest through the remaining period of your loan. You cannot claim this deduction if your 2015 MAGI is over $80,000 ($160,000 for married filing jointly).
- Deduction for Tuition and Fees. This deduction can reduce your income subject to tax by up to $4,000, and you do not have to itemize your deductions to claim it. To be eligible for the deduction, you must pay qualified education expenses for a student you claim as a dependent on your tax return. Room and board is not a qualified education expense for purposes of this deduction, and you cannot claim this deduction if your 2014 MAGI is over $80,000 ($160,000 for married filing jointly). This deduction expired December 31, 2014, so unless you have not yet filed your 2014 tax return, it will not be available for 2015, unless restored by Congress.
- Deduction for Business Expenses. If you are self-employed, you can deduct expenses for qualifying work-related education directly from your self-employment income. Your income subject to income tax and self-employment tax will be reduced. If you are an employee and itemize your deductions, you may be able to claim a deduction for the expenses you pay for work-related education. For employees, this is a miscellaneous expense, which means you get a tax benefit only if all of your miscellaneous deductions exceed two percent of your adjusted gross income.
Exclusion of Scholarships and Other Receipts from Gross Income
Generally, scholarships, fellowships and other educational grants are excludible from gross income if they are received by an individual who is a candidate for a degree at a qualified educational institution and are not given in return for services provided by the student. A qualified educational institution is one that normally maintains a regular faculty and enrolled body of students.
- Qualified Tuition Programs (529 Plans). College savings plans permit you to establish a state-sponsored savings account for a student for the purpose of paying eligible college expenses. Earnings grow tax-free if the savings are used for qualifying education expenses. For Illinois residents, contributions to a Bright Start, Bright Directions or College Illinois savings program are deductible (up to $10,000, or $20,000 for married filing jointly, per year) on your Illinois state tax return.
- Coverdell Education Savings Accounts. Coverdell ESAs allow savings contributions to grow tax-free, and distributions are tax-free to the extent they are used for qualified education expenses. These savings accounts are for primary, secondary and postsecondary education, and contributions to the account are not tax-deductible.
- U.S. Savings Bonds. Interest received on Series EE and Series I savings bonds used for qualified tuition and fee expenses may be excluded from gross income. The bonds must have been issued after 1989, purchased when you were at least 24 years old, and be in your name—not your child’s name. You cannot exclude the savings bond interest from your income if your 2015 MAGI is over $92,200 ($145,750 for married filing jointly).
- Individual Retirement Accounts. Early withdrawal penalties are waived when Roth IRAs and traditional IRAs are used to pay the qualified post-secondary education costs of yourself, your spouse, your children or your grandchildren. The withdrawal must not exceed the qualified education expenses for the tax year. Amounts withdrawn from an IRA will still be includible in gross income.
- Tax-Free Educational Assistance. Scholarships and grants are tax-free if the recipient does not have to provide services in return for the reward and the amount of the award does not exceed qualified educational expenses. Additionally, employers may pay and deduct a specified amount of college and graduate school expenses, and the benefit is tax-free to the employee.
- Forgiveness of Student Loans. If you receive forgiveness of a certain student loan, you are allowed to exclude the amount from gross income if the forgiveness is contingent on working for a certain period of time in certain professions. Employer-provided forgiveness and loan repayment assistance programs do not qualify for tax-free treatment.
- Gift Tax Educational Exclusion. If you pay educational expenses on behalf of an individual to a qualifying educational institution, the payments are excluded from gift tax. The payment must be made directly to the institution and it must be for tuition. Books, supplies, room and board, or other similar expenses do not qualify for the exclusion.
Generally, you may claim any number of benefits as long as you use different expenses to figure each one. The portion of expenses paid with tax-free scholarships, fellowships, grants, education savings account funds, tax-free savings bond interest or employer-provided education assistance are not eligible for deductions or credits.
Education is expensive, but taking advantage of some of the federal and state tax incentives may help defray some of the costs. Care should be taken to ensure you choose the program that will benefit you most and that you meet all requirements to qualify for the particular benefit.
This material is provided for general information. You should discuss your specific tax situation with your tax advisor. iBi
Kristina Galligan, CPA is a senior tax accountant at Heinold Banwart, Ltd. She can be reached at (309) 694-4251 or firstname.lastname@example.org.