College Tax Benefits for Students and Parents

College Tax Benefits for Students and Parents

September 28, 2021

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College can be incredibly expensive. With the high costs of tuition, room, and board — combined with expenses for transportation, books, and supplies — it's amazing that 20 million students a year somehow manage to acquire the funds necessary to attend.

According to the National Center for Education Statistics, public in-state universities cost around $9,000 a year, while public out-of-state tuition sits at $19,000. Meanwhile, private nonprofit institutions cost about $29,000 in annual tuition and fees.

The rising cost of college has also caused a massive spike in student debt, which is currently at an all-time high of $1.7 trillion. Student debt is now the second-highest category of debt in the U.S., and those who take out loans pay an average of $1,898 in interest each year.

Student debt recently hit an all-time high of $1.7 trillion, making it the second-highest category of debt in the U.S.

College's steep price tag is also depleting the bank accounts of parents and other family members who may be helping to pay for a student's education.

The escalating costs associated with college has students and parents everywhere asking for a break. Fortunately, the U.S. government has stepped up by offering a variety of tax breaks for higher education. These breaks come in the form of tax credits, deductions, and other benefits, like tax-free savings accounts.

It's important for taxpayers to take advantage of these benefits. Whether you're a parent helping to support your dependent child's college education or a financially independent college student, these tax benefits could help you save thousands of dollars each year.

College Tax Credits

Tax credits are one of the best tax breaks available because they apply directly toward the amount of tax you owe, rather than just reducing the amount of income subject to tax. It's a dollar-for-dollar reduction. For example, if you had a $500 tax credit and owed $1,000 in taxes, your tax bill would be lowered to just $500 once the credit is applied.

There are two big education tax credits offered by the federal government: the American opportunity tax credit and the lifetime learning credit. As a taxpayer, you are allowed to only take one of these college student tax credits.

To claim either credit, you must use Form 8863. You'll also need Form 1098-T, which should be mailed to the student from the school and shows how much you paid for tuition and qualified expenses that year.

American Opportunity Tax Credit

The American opportunity tax credit (AOTC) provides a maximum annual credit of $2,500 per eligible student during the first four years of college. This credit may cover expenses associated with tuition, course materials, and any required fees. Note that expenses for room and board, transportation, medical care, insurance, and nonrequired fees are ineligible.

The amount of the credit is equal to 100% of the first $2,000 on qualified education expenses paid for each eligible student and 25% of the next $2,000. In other words, if your qualifying educational expenses are $4,000 or more, you would be allowed the maximum credit of $2,500.

If your qualifying educational expenses are $4,000 or more, you would be allowed the maximum AOTC credit of $2,500.

What's great about the AOTC is that it's refundable up to 40%. So even if the credit you receive brings your tax liability down to zero, you can still get up to 40% of what's left over, up to $1,000.

In order to qualify for the AOTC, students must be pursuing a postsecondary degree or other recognized education credential and be enrolled at least half time for one academic period (semesters, trimesters, or quarters) beginning that tax year.

Be aware that the AOTC maintains income thresholds. In order to claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married couples filing jointly). You can still receive a partial credit if your MAGI is above $80,000 and below $90,000, or $180,000 if filing jointly.

Lifetime Learning Credit

The lifetime learning credit (LLC) is similar to the AOTC but less restrictive. This credit is for qualified tuition and related expenses paid for eligible students attending eligible schools. Unlike the AOTC, however, there's no limit on the number of years you can claim the credit. In addition, you don't have to be pursuing a degree or be enrolled at least half time.

These qualities make the LLC more appealing if you are not an undergraduate student, are just attending college part time, or are taking career development courses. Note that the student does need to be enrolled for at least one academic period beginning that tax year.

The LLC is less restrictive than the AOTC — you don’t need to be pursuing a degree or be enrolled at least half time.

The LLC is slightly less valuable to taxpayers than the AOTC because it's not refundable, meaning you can't receive any of the credit back as a refund as you can with the AOTC. The amount of the credit provided by the LLC equals 20% of the first $10,000 of qualified education expenses, or a maximum of $2,000 per tax return.

Income thresholds for the LLC are fairly restrictive. You can only claim the credit if your MAGI is less than $69,000 ($138,000 for those filing jointly). The amount of the credit gradually drops if your MAGI is between $59,000 and $69,000, or $118,000 and $138,000 for joint filers.

College Tax Deductions

Tax deductions lower your tax liability by reducing the amount of income that's subject to tax. While not as valuable as tax credits, deductions can be highly beneficial and significantly reduce the amount of tax you owe. A lower adjusted gross income can also help you qualify for various other deductions and credits.

Tuition and Fees Deduction

Originally scheduled to be discontinued after 2017, the tuition and fees deduction was extended through the 2020 tax year as part of the Further Consolidated Appropriations Act.

This college tax deduction is an above-the-line deduction of up to $4,000 in qualified higher education expenses for eligible taxpayers. Qualifying expenses generally include tuition costs, along with any required fees, equipment, and supplies paid for during that tax year.

In order to be eligible for the full deduction, your MAGI must not exceed $65,000, or $130,000 for joint filers. Taxpayers whose MAGI is between $65,001 and $80,000 ($130,001 and $160,000 for joint filers) may deduct up to $2,000.

Student Loan Interest Deduction

The student loan interest deduction allows taxpayers to deduct any required or voluntary interest paid (up to $2,500) during the tax year on a qualified student loan used solely toward the payment of higher education costs for you, your spouse, or a dependent.

Private loans from family, friends, or employer plans do not count toward this deduction. The student must also be enrolled at least half time.

In order to qualify, your MAGI must be less than $70,000 ($140,000 if filing a joint return). If your MAGI is between $70,000 and $85,000, the amount you'll be able to deduct will be lower than the full $2,500. This deduction is claimed as an adjustment to income, so you don't need to itemize deductions in order to take advantage of it.

Other Education-Related Tax Benefits

In addition to tax credits and deductions, there are other ways to help offset taxes when paying for higher education.

Education savings accounts, like Coverdell and the 529 plan, offer tax-free earnings growth and tax-free withdrawals when the funds are used for qualified education expenses. The account holder does not have to pay tax on the annual growth on the original investment, and there is no tax paid on the funds that are withdrawn as long as they are used to pay education expenses.

You can also invest in an education savings bond program. With this program, you may be able to exclude interest from income when the qualified savings bonds are redeemed to pay for higher education expenses.

Other potential tax benefits for college students and parents include education savings accounts and education savings bonds.

In terms of IRA funds, while the IRS usually charges a 10% penalty if you withdraw funds early (before you reach age 59 and a half), if you use that money to pay for tuition and other qualified higher education expenses, it can be withdrawn without penalty. Note, however, that you may still have to pay income tax on the distribution.

For a complete rundown on all educational tax benefits, visit the IRS Tax Benefits for Education Information Center. You can also check with your state to see what benefits it offers. For example, New York offers a credit/deduction on qualifying college tuition.

U.S. tax laws, rules, and regulations are constantly changing, so be sure to consult an accountant or tax attorney before making any tax-related decisions.

Editor's Note: This article contains general information and is not intended to be a substitute for professional advice. Please consult a professional advisor before making decisions about financial issues.

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