Students can take advantage of tax credits, tax deductions, and tax-free savings plans to offset the cost of tuition, fees, room and board, travel, supplies, and other student expenses.
A tax credit is an amount you can subtract from the taxes you owe. It’s different from a tax deduction. Educational tax credits help you by reducing the amount of taxes you pay to the government. Sometimes credits cut your tax bill to zero, so you get a refund. The American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit are two such breaks in the United States tax code. Each one has a set of requirements of its own, but they share certain qualifications.
To qualify for educational tax credits, you must meet the following criteria:
- You must be paying qualified education expenses for yourself, a dependent, or another party to pursue in higher education.
- The student you are paying expenses for must be enrolled in an eligible educational institution.
- The student you are paying expenses for must be yourself, a spouse, or a dependent you claim on your tax return.
A tax deduction is different from a tax credit. A deduction is an amount that’s subtracted from your taxable income, usually leaving you with a smaller tax bill. If you pay expenses during the year related to higher education for yourself, your spouse, or your dependents, you may be able to claim some or all of those expenses as tax deductions. If you qualify, you can claim up to $4,000 per year.
You cannot take these deductions if you and your spouse file taxes as married filing jointly, and you cannot take the deduction if someone else, usually a parent, still claims you as a dependent on their tax return.
To claim this deduction, you complete IRS Form 8917 for Tuition Fees and Deductions and send it in as part of your tax return. You do not have to itemize deductions to take advantage of this break. It’s especially helpful if you don’t qualify for the AOTC or Lifetime Learning credit.
If you do qualify for all three options — the AOTC, Lifetime Learning credit, and the tax deductions — you should consider all of them to see which one is most to your advantage. You cannot claim the same expense under more than one type of deduction.
If you do decide the tax deduction works best for you, here are some specific types to consider.
Student Loan Interest Deduction
Usually, interest on loans other than your mortgage is not tax-deductible. However, if you meet the income guidelines, you can deduct interest on qualified student loans from your taxes in the year you paid it. It can take up to $2,500 off your taxable income, and you don’t have to itemize to take advantage of this benefit.
A qualified loan is one you took out for educational expenses for you, your spouse, or someone who was a dependent at the time of the loan. The expenses must have occurred reasonably soon after the loan. The loan cannot come from a relative or an employer plan.
Qualified education expenses include tuition, fees, room and board (with some limitations), books, supplies, equipment, travel, and anything else related to attendance at an eligible institution, including graduate school.
Business Deduction for Work-Related Education
Employees may be able to claim a deduction for work-related education if they itemize deductions on their taxes. To be able to deduct the expenses, they must equal more than 2 percent of your adjusted gross income (AGI). Such a deduction can lower your tax bill by reducing your taxable income. Self-employed workers can take the same deduction off the self-employment tax, which reduces both the taxable income and self-employment tax. To claim these deductions, you must:
- be employed or self-employed
- itemize deductions using Schedule A (employees only)
- file Schedule C, C-EZ, or F if you are self-employed
- have qualifying expenses for work-related education
Qualifying Work-Related Education
You can deduct expenses for this type of training or education if it meets one of these two conditions:
- It’s required by either your employer or the law to keep your job, current salary, or status. The education must serve a legitimate business need for your employer.
- It improves the skills you need in your current position.
However, even if the education qualifies under those conditions, it is still not deductible if it:
- Is needed to keep up minimum standards for your current job
- Is intended to qualify you for a new career or field
Tax-Free Savings Plans
Some college savings plans allow you to put money into an account that grows over time. Then you can withdraw the money when you need it to pay for higher education expenses. Some plans allow the money you put in to accumulate and draw earnings tax-free; some plans allow you to withdraw the money tax-free, and some plans allow you to do both tax-free.
Qualified Tuition Programs (529 Plans)
All 50 states and the District of Columbia have these programs. There are two types: prepaid tuition or savings plan.
- With a prepaid tuition plan, you buy units of tuition at today’s rates. When the student is ready to attend school, it is still worth one unit then.
- In the savings plan, you put away money that draws earnings and grows until you need it.
You can’t take a tax deduction for the money you put into these plans. However, when you take the money out to use it for higher education expenses, it’s not counted as income unless you take out more than you have in expenses like tuition, fees, books, supplies, equipment, travel, and more.
Coverdell Education Savings Account
A Coverdell account can be used for higher education, among other things, but it is subject to income limits on the contributors. It’s capped at $2,000 per student per year, regardless of how many accounts are set up. Beneficiaries must be under 18 years old unless they have qualifying special needs.
The money you put into a Coverdell is not tax-deductible, but it grows tax-free until you need it. When you take the money out, it’s not taxed as income unless you take out more than you need for your qualifying expenses.
This is just a partial list of the ways the tax code cuts you a break while you are pursuing higher education. Check them all out and save every penny you can while you’re chasing that dream.