September 5, 2014

Although the sun still shines brightly and the temps are still warm, September signals back to school time. Whether you’re sending your son or daughter to college for freshman year or returning to school yourself, there are books to buy, tuition to pay and other expenses galore. Uncle Sam also has your back, with back to school tax credits and deductions designed to lighten the financial burden of education.

Related article: Kid-Friendly Tax Breaks

American Opportunity Tax Credit

Thanks to the American Taxpayer Relief Act of 2012, commonly known as the “fiscal cliff” deal, the American Opportunity Tax Credit (AOTC) was extended through December 31, 2017. Students may claim the AOTC for the first four years of higher education. The AOTC covers tuition, books, required fees and educational equipment. The AOTC reduces the tax burden of eligible taxpayers on a dollar for dollar basis, with a maximum credit of $2,500 per year. If there are funds left over from the credit after eligible expenses are covered, taxpayers can receive up to $1,000 as tax refunds. Form 8863, available from the IRS website, is required to claim the AOTC.

Lifetime Learning Credit

The Lifetime Learning Credit (LLC) can be used for undergraduate, graduate and professional coursework, as well as coursework designed to improve job-related skills. The LLC is worth 20 percent of the first $10,000 of eligible educational expenses, reducing taxpayers’ tax burden dollar for dollar, up to a maximum of $2,000 per year. Form 8863 is used to claim the LLC, which is not refundable.

Tax-Exempt Scholarships and Fellowships

Scholarships and fellowships that are used exclusively for eligible educational expenses are tax-exempt. After deducting the tax-exempt portion of the scholarship or fellowship, students must declare the remainder of the scholarship or fellowship as income. (Finaid)

Tuition and Fees Deduction

As a substitute for claiming either the AOTC or the LLC, eligible taxpayers may claim a tax credit of up to $4,000 annually for tuition, fees and other eligible educational expenses paid out-of-pocket. Funds from a student loan that are used to pay tuition and fees are also eligible for claiming the deduction. The deduction offsets federal tax obligations dollar for dollar; taxpayers are not required to itemize to claim the deduction.

Business Deduction for Work-Related Education

Unlike the tuition and fees deduction, the business deduction for work-related education can also be applied to educational expenses such as seminars and workshops that are not conducted in colleges and universities. Taxpayers who claim the deduction must be working and the instruction must fit within one of the three following categories listed on the IRS website.

  • Education required by employers or the law maintain present salary, status or position
  • Education that serves a bona fide business purpose for taxpayers’ present employers
  • Education that maintains or improves skills for taxpayers’ present line of work.

Education required to meet minimum standards for a position or which qualifies individuals for a new line of work is not eligible for the deduction. Wage-earners must itemize deductions on Schedule A along with Form 1040. The business deduction for work-related education applies only to expenditures that exceed 2 percent of adjusted gross income (AGI). Self-employed individuals need not itemize to claim the deduction, and list eligible expenses for the business deduction for work-related education on Schedule C, Schedule C-EZ or Schedule F along with Form 1040.

Student Loan Interest Deduction

Uncle Sam has not forgotten taxpayers who are paying off student loans. Taxpayers may deduct the interest paid on student loans up to a maximum of $2,500 annually. Students must have been enrolled at least half-time at a qualifying educational institution when loans were taken. The student loan interest deduction reduces taxable income dollar for dollar; taxpayers need not itemize deductions to claim the deduction.

529 Savings Plans and Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (ESA) are established by third parties on behalf of a beneficiary, who must be under age 18 or a special needs individual when the fund is established. Contributions from all sources may not exceed $2,000 per year, and contributions are not tax deductible for donors.

However, beneficiaries may withdraw funds from Coverdell ESAs tax-free to cover eligible education-related expenses, including tuition, fees and books, along with room and board. Students may claim the AOTC or the LLC along with withdrawing funds from a Coverdell ESA, as long as the funds are applied to different qualified expenses. Withdrawals in excess of eligible expenses may be taxable, and all funds from a Coverdell ESA must be distributed by the beneficiary’s 30th birthday.

State or school-sponsored 529 savings plans allow taxpayers to contribute funds toward students’ eligible educational expenses for schools within a state or at a particular educational institution. There are no income or contribution limits for 529 plans. Deductions used for education-related expenses, including room and board for students enrolled at least half-time, are tax free.

IRA Withdrawals for Education

Ordinarily, deductions from Individual Retirement Accounts (IRAs) taken before the account holder reaches age 59 ½ are subject to a 10 percent penalty in addition to any taxes due. The IRS makes an exception for withdrawals used to cover educational expenses for adult students or eligible family members (usually children). The withdrawal may still be taxable unless the amount is less than the qualified educational expenses of the qualifying student.

Qualifying for Education Tax Breaks

Taxpayers are not usually allowed to “double dip” to claim multiple education-related tax credits and deductions during a single tax year, although there are exceptions. For instance, the AOTC and the LLC may not both be claimed for the same student during the same year, although families with multiple students may claim one credit for one student and a different credit for another student.

Several education-related tax credits and deduction, such as the AOTC and the LLC, have maximum income limits that vary according to the filing status and income of taxpayers claiming the tax breaks. Also, room and board are generally not considered eligible educational expenses, except for 529 plans, Coverdell ESAs and student loan interest deductions. A student loan counselor or an Optima Tax Relief specialist can sort out any questions concerning eligibility for education-related tax credits and deductions.