Elizabeth Rosen for the US Tax Center writes: There are a number of different education tax benefits that you may be able to claim on your Federal income tax return. This article provides a breakdown of the tax relief that is available for qualified tuition and fees expenses.
While tax credits and tax deductions can both help reduce your overall tax bill, it’s important to remember that they are not the same thing. A tax credit provides a dollar-for-dollar reduction of your income tax liability. This means that a $1,000 tax credit actually saves you $1,000 in taxes. On the other hand, a tax deduction is equal to the percentage of your marginal tax bracket, and lowers the amount of your taxable income. For example, if you are in the 25% tax bracket and you claim a $1,000 deduction, you will save $250 in taxes (because 0.25 × 1000 = 250).
As you can see, a tax credit will always save you more money than a dollar-equivalent tax deduction. This is due to the fact that tax deductions are calculated using percentages. Looking at the examples above, you’ll notice that a $1,000 credit saves you $750 more in taxes than a $1,000 deduction.
Your Adjusted Gross Income (AGI) is the number that represents your total annual income, minus certain adjustments (i.e., reductions to your income). Your eligibility for certain Federal tax benefits, and whether or not you can claim the maximum amount, will depend on your Modified Adjusted Gross Income (MAGI). Your MAGI is determined by taking your AGI and adding back certain items — including foreign income, student loan interest, qualified tuition expenses, rental losses, and IRS contributions.
American Opportunity Tax Credit
Qualified Expenses: Tuition, required enrollment fees, and course materials
Maximum Credit: Up to $2,500 per eligible student (100% of the first $2,000 of qualified expenses, and 25% of the next $2,000 of qualified expenses)
Limits on MAGI: $90,000 if single, head of household, or qualifying widow(er); $180,000 if married filing jointly
Program Requirements: Student must be degree-seeking and enrolled at least half-time
Time Limit: Available only for 4 tax years per eligible student
Type of Credit: 40% of the credit may be refundable; the rest is nonrefundable
Lifetime Learning Tax Credit
Qualified Expenses: Tuition and fees required for enrollment or attendance, including amounts paid to the institution for course-related materials
Maximum Credit: Up to $2,000 per tax return
Limits on MAGI: $63,000 if single, head of household, or qualifying widow(er); $127,000 if married filing jointly
Program Requirements: Student does not need to be degree-seeking and can be enrolled in one or more courses
Time Limit: Available for an unlimited number of years
Type of Credit: Nonrefundable (limited to the amount of tax you must pay on your taxable income)
Tuition and Fees Tax Deduction
Qualified Expenses: Tuition and fees required for enrollment or attendance at an eligible postsecondary educational institution, not including personal, living, or family expenses (such as room and board)
Maximum Deduction: Up to a $4,000 reduction of your taxable income
Limits on MAGI: $80,000 if single, head of household, or qualifying widow(er); $160,000 if married filing jointly
Program Requirements: Student must be you, your spouse, or your qualified dependent and enrolled in an eligible educational institution
Time Limit: Available for an unlimited number of years
Type of Deduction: Taken as an adjustment to income on Tax Form 1040 or Tax Form 1040A.
Employer-Provided Educational Assistance
Qualified Expenses: Tuition, fees, and similar expenses (such as books, supplies, and equipment)
Maximum Amount: Up to a $5,250 exclusion from your income
Limits on MAGI: None
Program Requirements: Does not have to be degree-seeking, and generally includes any form of instruction or training that improves or develops your capabilities
Business Deduction for Work-Related Education
Qualified Expenses: Tuition, books, supplies, lab fees, certain transportation/travel costs, and other similar education expenses (such as the cost of researching and typing a paper)
Maximum Deduction: The amount by which your qualifying work-related education expenses (plus other job and certain miscellaneous expenses) is greater than 2% of your AGI
Limits on MAGI: None
Program Requirements: Must be for qualified work-related education — which either maintains/improves the skills needed in your present work; or is required by your employer (or the law) to keep your present salary, status, or job.
Time Limit: Unlimited number of years
Type of Deduction: An itemized deduction (reported on Schedule A of Tax Form 1040) that reduces the amount of your taxable income
Gift Tax Exclusion for Tuition Expenses
Qualified Expenses: Tuition expenses paid directly to an educational institution for someone
Maximum Exclusion: Up to a $14,000 annual exclusion per donee
Limits on MAGI: None
Time Limit: Unlimited number of years
Type of Benefit: In general, any gift is a taxable gift and the donor is responsible for paying the gift tax. However, the direct payment of someone else’s tuition expenses is not considered a taxable gift, and is therefore exempt from the gift tax (up to $14,000 per year).
Conclusion
Keep in mind, the majority of education tax breaks are designed for taxpayers who are single filers or who use the “married filing jointly” filing status on their Federal return. Additionally, certain tax credits are categorized as “refundable” while others are considered “nonrefundable.” Also remember that the IRS will not allow you to claim different tax breaks for the same expenses (known as “double-dipping”), so make sure you understand which mixture of tax benefits works for you. You can read IRS Publication 970 (Tax Benefits for Education) for details about rules and eligibility.
Note that this article only covers tax breaks for tuition and fees, and there are many other types of education tax help available. For more information, stay on the lookout for the next part of this series — the upcoming article titled “Tax Benefits for Education: College Savings Plans.”
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