Believe it or not, the government really does want you to earn your college degree. And they're willing to give you a tax break to do it.
Are you thinking about going back to school to earn your degree but afraid it's too big of a financial commitment? Apparently, one entity feels your pain - the Internal Revenue Service (IRS).
Yes, you read correctly. The government actually wants to encourage higher education and is willing to give tax breaks - both in the form of tax credits and tax deductions - to students and parents of students. That could mean up to thousands of dollars off the cost of going back to school for you, your spouse, or your kid.
Perhaps this is a good time to note the distinction between a tax credit and a tax deduction: A tax credit is a reduction of your taxes owed, while a tax deduction reduces your taxable income. For most people, says Anthony Burke, public affairs specialist for the IRS, a tax credit will result in a larger savings.
How do you qualify for these savings? Below is an outline of the three most attractive tax credits and deductions. But first, you should know that you cannot combine these. In other words, says Burke, you must choose one of the following per student, per year. So, if you choose to take advantage of the Lifetime Learning Credit, you may not claim the American Opportunity Credit or the Tuition and Fees Deduction for the same student in the same year.
Taxes are simple enough, right? Don't worry - just keep reading to learn more about three possible educational tax savings and to get a better idea of how school could end up saving you.
American Opportunity Credit
Back in 2009, Congress established the American Opportunity Credit to replace the longstanding Hope Scholarship credit. It was a good development for students since it increased the credit and made it available through 2017.
The maximum credit you might be able to enjoy through the American Opportunity Credit is $2,500, according to Jana R. Payton, a principal tax research analyst at H&R Block. She adds one important distinction: the maximum refund amount is $1,000, which means if your total tax bill is $0, the refund you receive from this tax credit cannot exceed $1,000. But, if you owe, say, $2,500 in taxes, and can claim a $2,500 American Opportunity Credit, then you would pay $0 in taxes.
What types of educational expenses are eligible? Glad you asked: Tuition and fees, course-related books, supplies, and equipment can all go toward the credit. What doesn't count? Things such as room and board, and personal expenses - like costs for student insurance or athletics.
To qualify for the credit, you need to be enrolled at least half time in an accredited college or university for at least one academic period that begins during the tax year, according to Mark Steber, chief tax officer for Jackson Hewitt Tax Service, Inc. You can claim the credit if the student in question is yourself, your spouse, or your dependent.
Remember, though, you'll need proof. "It's important to keep receipts for any tax-related expenses you may have paid throughout the year," says Steber. "To claim education-related benefits, hold on to receipts for your tuition, fees, course materials, and your Form 1098-T, if you received one." To claim this credit, he says you'll need to use IRS Form 8863.
So, how about a little math to show how the credit works? Let's say your college expenses added up to $4,000. You would be able to claim 100 percent of the first $2,000, plus 25 percent of any amount over that. So for our example, you would claim $2,000 plus .25 X $2,000 for a total tax credit of $2,500. Which means that when you prepare your taxes for the year, you can subtract $2,500 from any amount that you owe.* See, you have learned something by being in school.
Lifetime Learning Credit
The Lifetime Learning Credit presents one more great opportunity for you to get some of your education expenses back in the form of a reduction on your tax bill. And unlike the American Opportunity Credit, the Lifetime Learning Credit is available for "all years of postsecondary education [college] and for courses to acquire or improve job skills," according to IRS Publication 970, "Tax Benefits for Education."
In other words, even if you aren't pursuing a degree, even if you're enrolled in as little as one course, this credit is available for you to claim. (The American Opportunity Credit, remember, is only available if you are going to school at least "half time" and in a degree program.)
According to Payton, the credit is available for 20 percent of up to $10,000 worth of qualified education expenses for a maximum allowable credit of $2,000. However, there is no refundable amount associated with the Lifetime Learning Credit. In other words, if you owe $0 but have a Lifetime Learning Credit of $1,000, sorry, you can't expect any cash back from the government.
Allowable expenses include tuition and fees, and course-related books, supplies, and equipment if paid to an institution as a condition of enrollment, says Steber. Things like room and board, transportation, insurance, and any personal fees don't qualify.
Again, you'll need solid proof in the form of receipts, cancelled checks, and school-generated 1098-T forms to get the credit, says Steber. Use the same Form 8863 when you file.
Time for math class again. Here's how to figure the deduction: Say you spend $12,000 on tuition, fees, and other applicable education expenses. A maximum of $10,000 of those expenses would qualify. When you find 20 percent of $10,000 (eh hem, by multiplying $10,000 by .20) you end up with your $2,000 tax credit.*
Tuition and Fee and Student Loan Interest Deductions
But that's where the simple math ends. These next deductions might as well be algebra. They aren't as straightforward as figuring your taxes owed, then lopping off the amount of the credit. Tax deductions, like the Tuition and Fee and Student Loan Interest Deductions, reduce the amount of your taxable income, making them a little more complicated to figure out.
These deductions will also figure different for each person, explains Payton. "Because it is a direct reduction of your income, your savings will depend on your tax rate."
And, like all good things in life, there is a limit. According to the IRS Pub 970, the Tuition and Fees Deduction can reduce your income subject to tax by up to $4,000 per return. In other words, if you made $30,000 of taxable income, a tax deduction of $4,000 means you would then only have $26,000 of taxable income.
Payton offers the following example. Say you have $4,000 worth of qualified expenses under this deduction. If your tax rate is 10 percent, that $4,000 deduction on taxable income would ultimately reduce your taxes owed by $400.* Allowable deductions under this category are "[t]uition and fees, and course-related books, supplies, and equipment only if paid to the [school or university] as a condition of enrollment," says Payton.
The Student Loan Interest Deduction applies to interest you pay for a student loan you take out for education expenses only, but the savings work the same way. The limit for this deduction is $2,500, says Steber, which means you can reduce your income subject to tax by up to that amount. If you have a student loan and paid more than $600 or more in interest during the year, your lender should send you a form 1098E, according to the IRS tax topic 456. You may still claim other qualifying interest not included on this form, such as loan origination fees.
It should be said that Publication 970, Tax Benefits for Education is 88 pages long and has other tax breaks for which you could qualify, so it's worth downloading from the IRS site (www.irs.gov/pub/irs-pdf/p970.pdf). It's also a good source for determining your eligibility, says Payton. If you're still having trouble making heads or tails of your tax situation, she advises seeking the help of a tax professional or using an online DIY program, which asks questions about your personal situation.
And if you're studying accounting, just consider this a little extra homework - the kind that pays off in more ways than one.
* Tax Credits and Deductions listed in this article may be reduced depending on your modified adjusted gross income (MAGI), according to IRS Publication 970 "Tax Benefits for Education."
|Educational Tax Incentives||Max
|Max Qualified Expenses|
|American Opportunity Credit||$2,500||$1,000||n/a||$4,000|
|Lifetime Learning Credit||$2,000||$0||n/a||$10,000|
|Tuition and Fee Deductions||n/a||n/a||$4,000||n/a|
|Student Loan Interest Deductions||n/a||n/a||$2,500||n/a|
Deduction and credit maximums for higher education expenses incurred during 2012 tax year.
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