Tax season isn’t often considered a fun time. But it is a chance to take advantage of certain educational tax benefits which you may be owed. Certain college and university expenses give eligible taxpayers access to credits, deductions, or both. And these can help lower the amount of federal taxes owed during a particular year.
Understanding which tax benefits are available is your first step to potentially lowering your tax burden. While not everyone qualifies for every credit or deduction that is out there, regardless of their or their dependent’s status as a student, it is important to know what options may be out there for you. That way, if you do qualify, you can get every dollar you may be owed.
It is important to note that this article is not intended to be tax advice. Instead, it is an overview of some of the current programs that may be available to you. To confirm your or your student’s eligibility for a tax credit or deduction, speak with a tax professional before filing.
Credits and Deductions: What’s the Difference?
Educational tax benefits come in two forms: tax credits and tax deductions. These are defined by the IRS as follows:
Tax credits reduce the amount of income tax the taxpayer has to pay while tax deductions reduce the amount of income that is subject to tax.
Both of these can lower the amount you owe in income taxes. Credits are generally fixed amounts that are subtracted from the total amount of taxes due based on your income. For example, if your tax burden is calculated as $5,000, and you qualify for a $1,000 educational tax credit, your tax burden changes to $4,000 to account for the credit.
Tax deductions are more complex. The amount of savings is based on your income bracket before and after the deduction. Before deductions, the amount of taxes owed is based on the total amount of income you make. For example, a household with $60,000 in annual income (with no other credits or deductions in play) owe taxes based on applying that amount to the standard IRS formula reflected in the IRS Tax Tables.
Deductions change the amount of your annual income that is applied to that formula. For example, a $1,500 tax deduction changes the taxable income from $60,000 to $58,500. That means you use the $58,500 number when performing the calculation instead of $60,000. The amount of savings generated from tax deductions varies depending on your unique situation, such as filing status.
Education Tax Credits
Currently, there are two primary education tax credits for which you may qualify: the American Opportunity tax credit and the Lifetime Learning tax credit. Each credit has some of its own requirements, though they have these three minimum requirements in common, per IRS rules:
1. You, or your dependent, must have paid qualified educational expenses for higher education during the tax year.
2. An eligible student must be enrolled at an eligible educational institution.
3. The eligible student must be either the tax filer, your legal spouse, or an eligible dependent that is listed on the tax return being filed.
Individuals must meet all three of the above criteria to potentially be eligible for either credit. Failure to meet any of those requirements means you or your student are ineligible.
Additionally, only one tax credit can be claimed each tax year, regardless of whether the student qualifies for both.
The IRS states “The American opportunity tax credit (AOTC) is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.”
The IRS also states “The Lifetime Learning Credit is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses--including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return.”
Education Tax Deductions
Two common tax deductions related to education are the Tuition and Fees deduction and the Student Loan Interest deduction. Both of these have the potential to lower your overall tax burden and be able to be used in conjunction with each other as well as with certain educational tax credits. You do not have to itemize deductions to take advantage of either of these deductions.
The amount you may qualify for varies depending on what expenses or interest were paid during the applicable tax year as well as your individual tax situation. However, the Student Loan Interest deduction eligibility is often easier to identify.
When you pay at least $600 in qualified interest payments during the year on a qualified student loan, you will receive a 1098-E from the loan company. The information on this form can be included in your tax filing and will clearly show the amount that may be deductible based on interest payments to that specific institution. To help determine eligibility, you can use this IRS online interview or speak with a qualified tax professional.
Other deductions related to tuition and fees is significantly more complex. The IRS provides general guidance regarding eligibility here, and you can work with a qualified tax professional to further clarify your eligibility.
Do Scholarships or Grants Affect My Taxes?
Scholarships and grants can affect your taxes, including eligibility for tax credits or deductions, but not all awards do. The IRS covers this topic specifically here and here. Any tuition and fee payments paid for by scholarship and grants are not eligible for credits or deductions.
Scholarships are tax-free if “used to pay for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies, and equipment required for courses at the educational institution.” When used for travel, room and board, this can require you to claim them in your gross income. Again, always consult with your tax professional.
However, even if scholarships or grants affect your taxes, generally the value of the scholarship or grant is higher than any associated downside they may have on your taxes. And that means it is always worth looking for new scholarship opportunities for you or your student.
It is also important to note that even if your student isn't still living at home, they may still qualify as your dependent. This is important, as explained by Adam Funk, CFP®, MSF:
Because parents typically earn more than students, parents more likely qualify for the maximum tax credit of up to $2,500. Whereas a student working part time owes little income taxes so they might only get the $1,000 refundable credit. Just because your child goes away to college and works part time doesn't mean you can't claim them on your tax return anymore.
If you want to learn a step-by-step process on how to find scholarships, join us for our next free webinar on the 6 Steps to Quickly Securing Scholarships for College.
Go to http://www.thescholarshipsystem.com/freewebinar to reserve your spot at the next training. Space is limited.
Taxes are Serious
As mentioned earlier in the article, not everyone qualifies for every credit or deduction. If you aren’t sure whether you or your student qualifies, discuss your options with a tax professional. They can help guide you through the complexities of qualifying for these tax benefits.
Remember, falsifying information on your tax return is a federal offense, and can come with notable financial and criminal repercussions. It is important that you thoroughly research your unique situation before adding any credits or submitting any deductions related to your tax situation.