Education Tax Credits: What Are They and How do I Use Them?

Many parents of college students look forward to reaping the rewards of an education tax break! Here are some examples of common tax breaks and credits they might receive. American Opportunity Credit The most valuable education tax break for most parents of college students is the American Opportunity Credit (AOC). You may be eligible to take this credit if you are paying the tuition and enrollment fees of a dependent student in the first four years of their undergraduate education. The AOC provides a credit equaling 100% of the first $2,000 of qualified expenses paid and 25% of the next $2,000. That means that parents paying at least $4,000 in qualified colleges expenses may be able to claim the maximum $2,500 AOC. Taxpayers with modified Adjusted Gross Incomes (mAGIs) less than $80,000 (single) or $160,000 (joint) can claim the full credit, while taxpayers with mAGIs up to $90,000 (single) or $180,000 (joint) may be eligible for a reduced credit. Forty percent of the credit is refundable, but before you go spending that refund check, you should be mindful of other education tax breaks you might already be receiving that may interfere with your claiming of the AOC. Lifetime Learning Credit (LLC) Parents of graduate students, part-time students, and students on a five-year undergraduate plan (i.e., they have already used four years’ worth of AOC) may be eligible for the Lifetime Learning Credit (LLC). The LLC provides an education tax credit equaling 20% of the first $10,000 of eligible expenses paid for a student, for a maximum credit of $2,000. Eligibility for the LLC phases out between $80,000 and $90,000 of income for single taxpayers, and between $160,000 and $180,000 for parents married filing jointly. Student Loan Interest Deduction If you are currently paying a loan borrowed for your child’s educational expenses, you may be eligible to deduct the interest paid this year from your taxable income, up to a maximum deduction of $2,500. Eligibility for this deduction phases out at AGIs between $70,000 and $85,000 for single taxpayers, and AGIs between $145,000 and $175,000 for parents married filing jointly. 529 Savings Plan Some parents may have saved in a 529 College Savings Plan and are now reaping the benefit of that tax-saving strategy. You are allowed to make tax-free withdrawals from a 529 Plan to pay for tuition, fees, special needs services, required books, supplies and equipment, and room and board (if studying at least half-time) of a qualified college student, without income limitations. In addition, you can repay up to $10,000 in student loans, $10,000 in K-12 tuition, and even roll up to $35,000 into the beneficiary’s Roth IRA. You’ve likely saved yourself a hefty tax bill over the years by saving and then paying your child’s college bill out of your 529 Planall of the earnings of that account can be used completely tax-free! This is one big caveat to all of this: there is no double-dipping! When planning your college payments, you should be aware that the IRS does not allow you to claim two education tax breaks for the same college expense. That means you can’t spend money out of your 529 Plan and count it towards your eligible expenses for the AOC. With this in mind, when planning your annual 529 withdrawals, you may want to actually hold back on $4,000 each year. Pay at least $4,000 of tuition expenses out of your income, a taxable savings account, or even with a loan, so that you may be eligible to claim the full $2,500 AOC. If you’ve already paid all of your child’s 2023 college expenses out of your 529 Plan, it may actually be in your best interest to pay taxes on the earnings portion of $4,000 worth of withdrawals (effectively not taking any tax break for that part of your 529 payment), so that you may then claim the full AOC. The benefit gained from the tax credit will likely be larger than the tax hit on your 529 withdrawal. For more information on coordinating education tax breaks, see IRS Publication 970, and before employing the above (or any other) tax-saving strategy, be sure to consult with your tax preparer.