Every year, millions of Americans struggle to figure out how in the world they are going to pay for their kids' higher education expenses. Tuition, fees, books, room and board, and miscellaneous expenses can be overwhelming for those who aren't prepared. Fortunately, the U.S. Government also wishes for its citizens to pursue higher education and is sympathetic to those in this dilemma. It has therefore offered a number of tax credits and other incentives toward this end that can provide substantial relief for many taxpayers, particularly those in the low- and middle-income brackets. This article examines the various credits and deductions available to students of higher education, and that are available for their parents.
One of the most effective methods of reimbursing taxpayers for higher education expenses is through tax credits. There are two main credits available for students of higher education, one of which was introduced in 2009. The American Opportunity Tax Credit has replaced the Hope Credit as the primary credit for undergraduate students. It can provide a credit of up to $2,500 per student for qualified higher education expenses, which includes tuition, books and miscellaneous course materials. This credit is offered for up to four years of undergraduate studies and is therefore both an improvement and an expansion on the Hope Credit, which was only applicable for the first two years of college and did not cover miscellaneous course materials.
It should be noted that students attending schools in designated Midwest disaster areas are still eligible to claim the Hope Credit for 2009, subject to certain restrictions. Eligibility for the AOC is phased out for single taxpayers with adjusted gross incomes from $80,000-90,000 (double these numbers for married taxpayers filing jointly). Furthermore, up to 40% of this credit is refundable for the majority of taxpayers, which means that filers claiming this credit can receive up to $1,000 per qualifying student, even if they owe no taxes. The Lifetime Learning Credit is available for students who have exhausted their AOC eligibility and provides a nonrefundable credit of 20% of qualifying educational expenses, up to a total of $2,000 (double these numbers for students attending schools in Midwestern disaster areas).
This credit is phased out for single taxpayers with AGIs between $50,000-60,000 and married taxpayers filing jointly with incomes between $100,000-120,000. All of these credits are claimed on IRS Form 8863 and then carried to the 1040. (For more, read 2009 Tax Credits: A Holiday Gift To Yourself.)
Tuition and Fees Deduction
Taxpayers with incomes above the AGI thresholds listed for the education credits may still be eligible to take an above-the-line deduction for qualified education expenses. Single taxpayers with AGIs between $60,000-80,000 and joint filers with AGIs between $120,000-160,000 can deduct up to $4,000 for these expenses, depending upon their income level.
Student Loan Interest
Single taxpayers with AGIs below $75,000 and joint filers with incomes below $150,000 can take an above-the-line deduction for interest on qualifying student loans. However, several conditions must be met in order to qualify for this deduction. The student must be or have been enrolled as at least a half-time student in a qualifying educational institution. The loan must have been taken out to pay qualifying expenses, such as tuition, books, fees and room and board. The taxpayer taking the deduction also cannot be claimed as a dependent on another taxpayer's return. Taxpayers who pay student loan interest should receive a Form 1098-E detailing the amount of interest that they paid during the year. (For more, read Loan Deferment Saves Students From Disaster.)
Coverdell Savings Accounts
The government has created a special type of savings account for students and their parents as another means of tuition assistance. The Coverdell Education Savings Account permits total annual contributions of up to $2,000 per student. The money in the account grows tax-free, as long as the withdrawals are used for qualified education expenses. These accounts are self-directed like IRAs, and the owners can invest the proceeds however they choose. (For more, see Clearing Up Tax Confusion For College Savings Accounts.)
Who Gets to Claim These Incentives?
In most cases, the taxpayer who actually pays the education expenses is the one who gets to claim them on the tax return. In some cases, both students and their parents may be eligible to claim a deduction or credit. When this happens, both parties should prepare sample returns to see which one gets the greatest amount of tax relief. Much of the time, it will be more beneficial for parents to claim the credit or deduction, because their income is usually higher than the student's. The parents should therefore probably claim the incentive, and perhaps reimburse the difference to the student. For example, if a student claims an incentive and would only get tax relief of $500, whereas the parents would receive $1,500, then the parents could claim the deduction or credit and pay the student $500 of their reimbursement from their tax return. This situation will vary from one family to another, and a tax advisor is often required to accurately determine the most advantageous way to do this.
The U.S. Government has created a variety of tax deductions and incentives designed to provide relief to students of higher education and their parents. The American Opportunity Tax Credit and Lifetime Learning Credit can provide dollar-for-dollar reimbursement up to a certain level, and expense and loan interest deductions are available as well. (For more information on student tax breaks, visit the IRS website at www.irs.gov or consult your tax or financial advisor. (For more, see Give Your Taxes Some Credit.)