Ready to save with education tax benefits? This guide will help.

If you are saving or paying for higher education for yourself or another student, then you already know: college is not cheap.

Educational costs in the United States have tripled over the past twenty years, making this country one of the priciest places in the world to get a higher education. As such, tuition, fees, and other expenses associated with education can represent a significant financial hurdle for many families.

In another post, I discuss savings options for college. In this post, I go through some of the tax benefits in the tax code, which also helps.

If eligible, you can take advantage of one or more of these benefits, including tax credits, deductions, savings plans, scholarships and fellowships, and income exclusions. Are you ready to ease your financial burden and make higher education more affordable for your family? Read on.

Can I claim an education credit or deduction on my taxes?

There are several tax credits and deductions available to help offset the cost of higher education. For example, depending on your eligibility, you may be able to cut your tax bill by as much as $2,500.

If a credit reduces your tax obligation to less than zero, you may even get a refund.

Furthermore, if you paid for college with student loans, you may still be able to claim one or more of these credits.

First, it’s important to understand the distinction between a tax credit and a deduction.

A deduction reduces your adjusted gross income (AGI). This has the effect of reducing your taxes since your taxable income is lower.

However, a credit reduces your actual taxes dollar-for-dollar by decreasing your payments or increasing your refund. For this reason, credits are often more valuable than deductions.

How do education tax credits work?

There are two education tax credits available from the IRS: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC).

While there are additional rules for each credit, and income limitations apply, to claim either the AOTC or LLC credit, you must meet all three of the following qualifications.

  1. You, your dependent, or a third party pays qualified education expenses for higher education.
  2. An eligible student must be enrolled at an eligible educational institution.
  3. The eligible student is yourself, your spouse, or a dependent you list on your tax return.

So, what does each credit do?

The American Opportunity credit is best for undergraduate students and their parents. It covers 100% of the first $2,000 of qualified expenses and 25% of the next $2,000, with a maximum of $2,500 annually.

“Qualified expenses” include tuition and fees, books, supplies, equipment, and required course materials. Room and board, unfortunately, are not qualified expenses for this credit.

Additionally, the AOTC is refundable up to 40%. That means that if it brings your tax bill to zero, up to $1,000 of the credit may apply to your refund.

To be eligible for the AOTC, a student must:

  • Be pursuing a degree or other recognized education credential.
  • Be enrolled at least half time for at least one academic period (semesters, trimesters, quarters, or any other period as determined by the school) beginning in the tax year.
  • Not have finished the first four years of higher education at the beginning of the tax year.
  • Not have claimed the AOTC or the former Hope credit for more than four tax years.
  • Not have a felony drug conviction at the end of the tax year.

You cannot claim the AOTC if your modified adjusted gross income (MAGI) exceeds $90,000 (or $180,000 if you are married and filing jointly).

You may claim a reduced amount of the credit if your MAGI is between $80,000 and $90,000 ($160,000-$180,000 for married filing jointly).

Only those with a modified adjusted gross income of $80,000 or less can claim the full credit.

The Lifetime Learning Credit

The Lifetime Learning Credit, on the other hand, helps pay for undergraduate, graduate, and professional degree courses—including courses to acquire or improve job skills.

This credit allows you to claim 20% of the first $10,000 of education expenses, up to $2,000 maximum. If you are ineligible for the AOTC, you may still qualify for the LLC.

The Lifetime Learning Credit is nonrefundable, but it is less restrictive in some ways than the AOTC. For example, all years of secondary education are eligible, a student must only enroll in a minimum of one course to qualify, and the student need not be pursuing a degree or credential. There are also no additional restrictions related to felony drug convictions, as in the AOTC.

Take care when claiming either of these credits to make sure that you qualify. And remember, if you are eligible for both credits for the same student in the same year, you must choose only one to claim.
If you are in doubt, we can help. Contact us here.

What education expenses are tax-deductible?

While the tuition and fees deduction is eliminated for tax years after 2020, other helpful deductions remain available. For example, the student loan interest deduction can reduce your taxable income if you have already started paying back your loans.

This tax code provision allows you to deduct up to $2,500 spent on student loan interest payments. You don’t need to itemize for this above-the-line deduction, but there are other restrictions. The educational institution must meet specific eligibility standards, and the interest must have been paid or incurred within a reasonable amount of time before or after you took out the loan.

Furthermore, you must have taken the loan out solely to pay for qualified education expenses for you, your spouse, or a person who was your dependent at the time of the loan.

In this case, the definition of “qualified education expenses” is a bit broader: it includes not only tuition, fees, books, and supplies, as in the case of the credits discussed above, but also transportation expenses and room and board.

You can claim the student loan interest deduction if all of the following apply:

  • You paid interest on a qualified student loan in the preceding tax year
  • You’re legally obligated to pay interest on a qualified student loan
  • Your filing status isn’t married filing separately
  • Your MAGI is less than a specified amount which is set annually
  • Neither you nor your spouse, if filing jointly, can be claimed as dependents on someone else’s return

What is an education savings plan?

If you are saving for college, depositing money into a particular education savings plan account can have valuable tax benefits. Contributions made to an eligible account are not federally tax-deductible, but the earnings accumulate tax-free. In addition, you will not owe tax on distributions if they are less than the beneficiary’s qualified education expenses.

There are three state and federal college saving vehicles you can use to maximize your tax perks: 529 (Qualified Tuition) plans, Coverdell Education Savings Accounts (ESA), and Custodial Accounts (UTMA/UGMA). Each option has unique advantages and drawbacks, and the best strategy for you will depend on your location, income, and circumstances.

We went into more detail on all of these education savings plans in a recent blog post. To discover more, take a look at that article here.

Are scholarships and fellowships taxable?

Some scholarships or fellowships do count as taxable income in the eyes of the IRS. However, if your scholarship or fellowship is tax-free, you do not need to report it on your return.

A scholarship or fellowship is tax-free if, and only if:

  • You are a candidate for a degree at an eligible educational institution
  • You use the scholarship or fellowship to pay qualified education expenses

Tuition, fees, and course-related expenses such as books, supplies, and equipment required of all students fall under the category of “qualified education expenses” in this case. Room and board, travel, research expenses do not qualify, nor do costs related to clerical help, equipment, or other expenses not required for enrollment or attendance.

If your scholarship or fellowship meets the above requirements, then it is tax-free to the extent that it does not exceed and is used only for your qualified education expenses.

Are there other education tax exclusions?

Although scholarships and fellowships are the most critical exclusions, a few other educational assistance benefits may be tax-free.

For example, if you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits per year.

And if you cash in qualified U.S. Savings Bonds to pay for eligible education expenses, you may be able to exclude the bond interest, depending on your income level.

The tax benefits outlined in this article may not necessarily offset the majority of your educational expenses. But with the cost of higher learning getting more expensive all the time, every little bit helps. As always, if you are in need of further information or guidance, we stand ready to assist you.

Would you like some help?

If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.

If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested? Contact us here to set up a no-obligation consultation.

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Jeff Coyle, CPA

Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.

He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.

His business experience includes:

Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.

Jeff also has a long history of helping individuals manage their taxes and plan their finances including:

Income tax planning and strategy.
Filing quarterly and annual taxes.
Audit support.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.

Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.

Jody H. Chesnov, CPA

Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004.  After a career of public accounting and general management, Jody knows the value of good financials.  Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.

He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles.  His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.

He has a particular expertise in early-stage growth companies.  His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.

Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller.  He has experience across industries, which gives him a deep understanding of business.

Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.

In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.  

He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.

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