When it comes to education, most financial planning centers around saving and investing for college. This focus makes sense because we’d all like to be able to cover our education expenses that way in an ideal world and not need to borrow a dime. But in the real world, that’s rarely the case.
Fortunately, parts of the tax code 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 during the tax-filing season. So 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 (AOTC)
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 credit phases out once your modified AGI reaches $80k for those filing single or $160k for joint filers. On the other hand, 40% of it is refundable for people who don’t earn enough to owe income taxes.
The Lifetime Learning Credit (LLC)
This credit is similar to the American Opportunity Credit, but it’s a little smaller. This credits up to $2k or 20% of the first $10,000 in expenses. That amount begins to phase out when MAGI exceeds $80k or $160k. These amounts will not adjust for inflation for the foreseeable future. It’s also a nonrefundable credit, whereas the AOTC may be refundable. The credit max of $2,000 is per tax return (per family) and not per student.
However, it’s more flexible since it’s not limited to undergraduate education. Thus, you can use it for graduate or qualified job-related programs or just a few courses you take here and there. Unfortunately, you cannot take Both credits for the same student in the same year.
Tuition and fees deduction
This deduction expired at the end of 2017 and was renewed retroactively in December 2019. So, if you had tuition and fees that were deductible from 2018 to 2020 that you didn’t claim (because they had not extended the law at that time), it’s worth looking into amending your tax return to request a refund.
It’s important to point out that you can only use one of these tax breaks (assuming you qualify). These tax breaks also don’t apply if you’ve used funds from another tax-free account, like a 529 plan or Coverdell account. They also don’t apply if you’ve used other forms of tax-free educational assistance like Pell grants or 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.) So the trick here is to withdraw money from a 529 or Coverdell account for no more than the amount of qualified expenses that aren’t covered by one of these other tax breaks.
Student loan interest deduction
The tax benefits don’t necessarily stop with the tuition bills. Suppose no one can claim you as a dependent on someone’s tax return. Your MAGI is also less than $85k or $170k joint (with phase-out beginning at $70k or $140k joint). In that case, you can deduct (without having to itemize) up to $2,500 of interest yearly 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, which can be an education in itself. So why isn’t there a special tax break for that?