Higher education financial planning requires patience, adaptable strategies, and many different methods for saving ahead for college. One of the most overlooked opportunities, however, is understanding education tax credits and deductions. Many students and their parents don’t realize that there are many tax-based benefits for getting a college education. These small tax strategies for saving on education can result in big impacts when it comes to avoiding high-interest debts. Our short education tax planning guide will cover your most common questions, such as, “Who qualifies for the education tax credit” or “what is a 529 plan for college?” Let’s make sure you and your child are fully informed before they go off to school!
Education Tax Credits
Tax credits provide a dollar-for-dollar reduction in your tax liability. Here are two education-related tax credits that can help offset the cost of qualified education expenses.
American Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit (AOTC) is available for eligible students pursuing post-secondary education.
- Maximum Credit: The AOC allows a maximum annual credit of $2,500 per eligible student.
- Qualifying Expenses: The credit applies to qualified tuition, fees, and course materials for the first four years of post-secondary education.
- Income Limits: The credit gradually phases out for taxpayers with modified adjusted gross incomes (MAGI) above certain thresholds.
Lifetime Learning Credit
The Lifetime Learning Credit (LLC) provides a credit for qualified education expenses, including undergraduate, graduate, and professional degree courses.
- Maximum Credit: The LLC allows a maximum annual credit of up to $2,000 per tax return.
- Qualifying Expenses: The credit applies to tuition and fees for eligible courses, including courses taken to acquire or improve job skills.
- Income Limits: The credit also phases out for taxpayers with MAGI above certain thresholds.
State Scholarship Contribution Tax Credits
Not only for those going to school, but for anyone who can afford to donate to a scholarship fund, state scholarship contribution tax credits are available in several states, such as Georgia. Each state has its own rules, but generally the donations must go toward a nonprofit, scholarship-granting organization.
Education Tax Deductions
In addition to tax credits, there are tax deductions available for education expenses. Unlike tax credits, deductions reduce your taxable income. Here are two common education-related tax deductions:
Student Loan Interest Deduction
If you’ve taken out student loans to finance your education, you may be eligible for the student loan interest deduction. Not all types of interest are deductible; find out more with our student loan interest guide. This is reported to you in Form 1098-E. (Find out how to get a hold of your document here.)
- Deductible Interest: You can deduct up to $2,500 of qualified student loan interest paid during the tax year.
- Income Limits: The deduction begins to phase out for taxpayers with MAGI above certain thresholds.
- Qualifying Loans: The deduction applies to interest paid on qualified student loans taken out for higher education.
Wondering when to start paying back your loans? Read about student loan payback strategies.
Tuition and Fees Deduction
The tuition and fees deduction allows you to deduct qualified education expenses for yourself, your spouse, or a dependent.
- Deductible Expenses: You can deduct tuition and required fees paid to an eligible educational institution.
- Income Limits: The deduction also phases out for taxpayers with MAGI above certain thresholds.
- Qualifying Institutions: The deduction applies to eligible post-secondary educational institutions.
Education Savings Plans
Education savings plans, such as 529 plans and Coverdell Education Savings Accounts (ESAs), provide tax-advantaged ways to save for education expenses.
529 Plans
This tax-advantaged account is designed for families to save for the education of their children. Parents and grandparents generally choose from either prepaid tuition or college savings plans. There are many advantages and disadvantages of relying on 529 plans.
- Tax Benefits: Contributions to a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free.
- Qualified Expenses: 529 plans cover a wide range of qualified education expenses, including tuition, fees, books, supplies, and certain room and board costs.
- State Tax Benefits: Some states offer additional tax benefits, such as tax deductions or credits, for contributions to a 529 plan. Find out more about your state’s 529 options here.
Coverdell Education Savings Accounts (ESAs)
A Coverdell ESA is another type of college educations savings account. Unlike 529 plans, Coverdell ESAs often have some income level restrictions as well as some other key differences.
- Tax Benefits: Contributions to a Coverdell ESA grow tax-free, and withdrawals for qualified education expenses are also tax-free.
- Qualified Expenses: ESAs cover qualified education expenses for elementary, secondary, and post-secondary education.
- Contribution Limit: The maximum annual contribution per beneficiary is $2,000 until age 18.
Employer-Provided Education Assistance
Some employers offer education assistance programs to their employees, which can provide tax benefits. Here are two common programs:
Employer-Offered Educational Assistance Programs
An employer can offer assistance with undergraduate or graduate education, including covering books, supplies, expenses, or even tuition.
- Tax Exclusion: Under certain circumstances, your employer may provide up to $5,250 per year in tax-free educational assistance.
- Qualified Expenses: The educational assistance can be used for tuition, fees, books, supplies, and equipment required for courses.
- Employer Requirements: The education assistance program must meet specific criteria outlined by the IRS to qualify for tax exclusions.
Important Tax Forms
Here is what you should supply to your accountant next tax season:
- 1098-T: Your tuition statement.
- 1098-E: Your student loan interest statement.
- 1099-Q: Your statement of distributions/payments from your qualified tuition program (such as a Coverdell ESA or 529 plans).
Your accountant will use Form 8863 to claim your education credits and Form 8917 for your tuition and fees deduction. Education tax planning can significantly impact your financial situation while investing in education. By understanding the available tax credits, deductions, and savings plans, you can strategically plan your education expenses and maximize your tax benefits. Consult with a tax professional to ensure you optimize your education-related tax savings and make informed decisions that align with your educational goals.
