IRS Publication 970, Tax Benefits for Higher Education, is a great source for tax information regarding the tax benefits available to students and graduates.
For 2010, there are two education tax credits to help you offset the costs of higher education tuition by reducing the amount of your income tax. Tax credits are subtracted directly from the tax a family or student owes. The two are the American Opportunity Hope Credit and the Lifetime Learning Tax Credit.
American Opportunity Credit
Designed to be used to lower the costs of the first four years of college, the American Opportunity Credit allows an eligible tax filer to claim a tax credit up to $2,500 for qualified educational expenses. The credit is subtracted from the tax your family owes instead of from taxable income like a tax deduction. To receive the American Opportunity Credit, a family or student must file a federal tax return and owe taxes. Families and students that do not pay taxes cannot receive the American Opportunity Credit. If your family owes less in taxes than the maximum amount of the American Opportunity Credit, you can receive a refund of up to 40% of the amount of the credit you are eligible to receive, up to $1,000. The amount of credit is reduced for those with modified adjusted gross incomes (MAGI) of $90,000 or more for single filers, head of household or qualifying widow/er (and $180,000 or more for joint returns).
An eligible student is one who is enrolled at least half time in an eligible program leading to a degree or certificate at an eligible school during the calendar year. The eligible student must not have been convicted of a federal or state felony drug offense before the end of the tax year in which he/she is enrolled. The American Opportunity Credit is for amounts paid in 2009 and 2010 only.
The Lifetime Learning Tax Credit
Like the American Opportunity/Hope Credit, to receive the Lifetime Learning Tax Credit, a family or student must file a federal tax return and owe taxes because the amount of the credit is subtracted from the taxes owed. Individuals who do not pay taxes are not eligible for the Lifetime Learning Tax Credit. If your family owes less in taxes than the maximum amount of the Lifetime Learning Tax Credit for which your family is eligible, you can take only the credit for the amount you owe in taxes.
A family may claim a tax credit of up to $2,000 per tax year for the taxpayer, taxpayer’s spouse, or any eligible dependents for an unlimited number of tax years. The amount of the credit is 20% of the first $10,000 of qualified educational expenses paid for all eligible students. Unlike the American Opportunity Credit which is only available for four years, the Lifetime Learning Tax Credit is available for all years of postsecondary education and for courses taken to acquire or improve job skills. The actual amount of the credit depends on a family’s income, the amount of qualified tuition and fees paid, and the amount of certain scholarships and allowances subtracted from tuition. This credit is family-based (up to $2,000 per tax return), unlike the American Opportunity Credit which is based on the number of eligible dependents in a family. The credit amount is gradually reduced for families with incomes between $50,000 and $60,000 if single, or between $100,000 and $120,000 if married.
To receive the American Opportunity Credit or the Lifetime Learning Tax Credit, the taxpayer must report the amount of qualified tuition and fees paid, as well as the amount of certain scholarships, grants, and untaxed income used to pay tuition and fees and complete IRS Form 8863.
Tuition and Fees Deduction
A tax deduction is subtracted from taxable income. Generally, a tax credit is more beneficial financially than a tax deduction. However, you should know about the Tuition and Fees Deduction. You may be able to deduct qualified education expenses paid for you, your spouse, or your dependent. The Tuition and Fees Deduction can reduce the amount of your income subject to tax by up to $4,000; it is taken as an adjustment to income. This means you can claim the deduction even if you do not itemize deductions on Schedule A of Form 1040. This deduction may be beneficial to you if you cannot take either the American Opportunity or Lifetime Learning Credit because your income is too high. The amount of qualified education expenses that can be deducted is $4,000 for taxpayers with a modified adjusted gross income (MAGI) of $65,000 or less ($130,000 or less for married couples filing jointly). The maximum Tuition and Fees Deduction is $2,000 for taxpayers with a MAGI greater than $65,000 ($130,000 for married couples filing jointly), but not greater than $80,000 ($160,000 for married couples filing jointly). Taxpayers with a MAGI greater than $80,000 ($160,000 for married couples filing jointly) are not eligible for this deduction. The Tuition and Fees Deduction cannot be used in conjunction with the American Opportunity Credit or the Lifetime Learning Credit. Please note that this tax benefit usually has a lesser impact on lowering your taxes than the American Opportunity Credit or the Lifetime Learning Credit.
Employer Provided Educational Assistance
Employers may provide tax free tuition benefits up to $5,250 per year for study leading to a degree. Tax free educational assistance benefits include payments for tuition, fees and similar expenses, books, supplies and equipment. The payments may be for undergraduate or graduate level courses and the courses do not have to be work-related.
Student Loan Interest Deduction
Student Loan Interest Deduction allows you to deduct, for federal tax purposes, all student loan interest paid in any tax year. Federal and private educational loans are eligible, but not family or employer loans. The deduction may be taken in any year in which student loan interest is paid. You can reduce your income subject to tax by up to $2,500. The Student Loan Interest Deduction is available if the student's MAGI is less than $75,000 (or $150,000 if married and filing jointly). The amount of your student loan interest deduction is gradually reduced if your MAGI is between $60,000 and $75,000 ($120,000 and $150,000 if married, filing jointly). For those who wish to take advantage of this deduction, and qualify, IRS form 8917 must be completed and attached to form 1040 or 1040A.
The following can be considered student loan interest:
- Loan origination fees
- Capitalized interest
- Interest on revolving lines of credit
- Interest on refinanced student loans
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. 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.
For further information, go to www.irs.gov and search for the latest issue of Publication 970.