Understanding tax breaks for higher education

Posted on February 22, 2013

If you’ve been effected by the economic downturn and decided to return to school to further your own education, or you support a dependent that is a college student, there are three education tax breaks that you should be aware of.

Each of the three is unique, and only one of them can be claimed for any particular student in a given tax year. But, you can claim one type of education credit for a child, for example, and another type of credit for yourself.

The three most common tax breaks for higher education are:

  1. American Opportunity Credit (AOC)
  2. Lifetime Learning Credit (LLC)
  3. Tuition and fees deduction

All three of these tax benefits can be claimed regardless of whether you itemize or claim the standard deduction. The AOC and LLC are claimed using Form 8863, and while the IRS didn’t start processing tax returns filed with this form until late in the current tax return filing season, they are now doing so. The tuition and fees deduction is claimed using form 8917.

A few legislative notes:

  1. The “fiscal cliff” bill passed Jan 2, 2013 by Congress extended the AOC through tax year 2017.
  2. The same law also retroactively extended the tuition and fees deduction through tax year 2013, since it actually had expired at the end of 2011.
  3. The LLC is a permanent part of the tax code (at least for now – that could change tomorrow, of course).

It should be noted that none of these tax benefits can be claimed by a non-resident alien, nor a person filing as Married Filing Seperately.

The AOC is aimed at full time college students completing their first four years of undergraduate education. Students must be at least a half-time student for at least 5 months out of the year to claim this credit, and they must also not have any felony drug convictions. The Lifetime Learning Credit, as the name implies, is applicable to all students, including part-time and graduate students. The tuition and fees deduction generally provides the least direct tax benefit, but can usually be claimed by people that can’t claim one of the other two for some reason.

The most common reason for not being eligible for one of the other two tax credits is due to income limitations. For 2012, the AOC starts to phase out for single taxpayers with adjusted gross incomes over $80,000 (double that for married couples), and the LLC starts to phase out for single taxpayers with AGI’s over $52,000 (also doubled for married couples).

The AOC can be as much as $2,500, and up to $1,000 of that is refundable. These amounts are per student. Refundable credits increase your refund even when your annual tax liability is zero. The AOC is also the only education tax break for which expenses other than tuition and fees can be claimed. The most common example is textbooks, which are AOC-eligible expenses, but are not for the other two tax breaks.

The LLC can be a maximum of $2,000 for an entire tax return, and is not a refundable credit. This means that the LLC can be used to reduce your tax liability to zero, but you don’t get a refund of the excess.

The tuition and fees deduction is just that — a deduction against taxable income. The maximum deduction for 2012 is $4,000, and the full amount can be claimed by joint filers with modified AGI of up to $130,000 (half that for single filers). The tuition and fees deduction requires only one course to be taken, and it does not need to be part of an actual degree program, but it does still need to be taken at an eligible post-secondary institution.

One of the most common questions I get regarding education tax breaks has to do with what’s reported on the student’s 1098-T. The tuition and fees reported on the 1098-T may actually differ from what you can actually claim as expenses for the tax credits, so be sure to speak with a tax professional or refer to the form instructions for clarification on what to actually claim.

It should also be noted that tuition and fees paid with loan proceeds are still eligible to be claimed, but not so for tuition paid with scholarships, grants, and tuition assistance. You must subtract scholarship and grant money from tuition and fees paid, and only claim the remainder for purposes of these education tax breaks. Also note that scholarship money in excess of tuition could be taxable income, and if it’s used to pay for living expenses, it’s definitely taxable income.

If you or a dependent are in school, I would encourage you to take advantage of these tax breaks. Remember the motto: Pay what you are legally required to in taxes, but not a single penny more!

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