When it comes to education, most financial planning is centered around ways to save and invest for college. This makes sense because in an ideal world, we’d all be able to cover all our education expenses that way and not need to borrow a dime. But in the real world, that’s rarely the case.
Fortunately, there are parts of the tax code that can help lift some of that burden if you know how to use them. As you can imagine, this is an area that we get a lot of questions about this time of year. Let’s take a look at some of these tax breaks and how you might be able to qualify for them.
The American Opportunity Credit
Since it’s a credit, you can deduct this one right off your taxes up to $2,500 (100% of the first $2k of eligible expenses and 25% of the next $2k) per student (you, your spouse or a dependent) for up to 4 years of undergraduate tuition and required fees and materials, including books.
However, the amount of the credit begins to phase out once your modified AGI goes above $80k or $160k for a joint return. On the other hand, 40% of it is refundable for people who don’t earn enough to owe income taxes.
The Lifetime Learning Credit
This credit is similar to the American Opportunity Credit but it’s a little smaller—up to $2k—and that amount begins to phase out when MAGI exceeds $58k or $116k for a couple. It’s also nonrefundable.
However, it’s more flexible since it’s not limited to undergraduate education and thus can be used for graduate programs or just a few courses. Both credits can’t be taken for the same student in the same year though.
Tuition and fees deduction
In case you didn’t know, this deduction expired at the end of 2017 and it was not renewed, so it is no longer relevant for the 2018 tax year going forward.
No double dipping
It’s important to point out that you can only use one of these tax breaks (assuming you qualify) and they don’t apply to funds you used from any other tax-free account like a 529 plan or Coverdell account, or by other forms of tax-free educational assistance like Pell grants and veterans’ programs.
In other words, there’s no double dipping allowed. (This restriction doesn’t apply to funding sources that are generally tax free like loans or inheritances and gifts.) The trick here is to withdraw from 529 and Coverdell accounts no more than the amount of qualified expenses that isn’t covered by one of these tax breaks.
Student loan interest deduction
The tax benefits don’t necessarily stop with the tuition bills. If you’re not a dependent on someone’s tax return and your MAGI is less than $85k or $170k joint (with phase out beginning at $70k or $140k joint), you can deduct (without having to itemize) up to $2,500 of interest each year on student loans that you’re legally obligated to pay. That last part means you can’t deduct interest for loans in your children’s names even if you make the payments.
Education is expensive and is rising faster than inflation. The good news is that we can offset some of that cost on our taxes. The bad news is that these breaks can be complex so unless you have a good tax preparer, you’ll have to take some time to understand them and that can be an education in itself. Why isn’t there a special tax break for that?