Tax Credits and Deductions for College And Graduate School Education

With students going back to college and graduate school this month, it is important to be aware of the tax credits and deductions related to education expenses that you will be able to take advantage of on your Federal Income Tax returns.

I. Tax Credits

There are two tax credits available to taxpayers who pay for qualified education expenses this year. Tax credits directly reduce the amount of tax you owe, as opposed to a deduction which reduces the amount of taxable income. Although you may have qualifying education expenses for each credit, only one of the credits may be taken on your tax return for each student. For example, if you claim the Lifetime Learning Tax Credit for a child on your tax return, you cannot also claim the American Opportunity Tax Credit for the same child in the same tax year. Additionally, for both credits, in order to claim either tax credit, you must meet the following requirements:

  1. You must either be the student or the student is your dependent (if the student can be claimed as a dependent by someone, he or she cannot take the credit themselves).
  2. You pay qualified education expenses of higher education.
  3. You pay the education expenses for an eligible student.

A. American Opportunity Credit

The first of the two tax credits available for education expenses is the American Opportunity Credit. You are able to claim a credit of up to $2,500 for adjusted qualified education expenses paid for each student who qualifies for the American Opportunity Credit. Qualified education expenses include: 1) Tuition; 2) required enrollment fees; and, 3) course materials that the student needs for a course of study whether or not the materials are bought at the educational institution as a condition of enrollment or attendance.

To qualify for the American Opportunity Credit, the following requirements must be met:

  1. The student must be enrolled in a program that leads to an undergraduate or graduate degree, certificate, or other recognized education credential;
  2. The student must be enrolled at least one half the normal full time course load for that course of study;
  3. The student cannot have already completed four years of post secondary education; and
  4. Neither the American Opportunity Credit nor the Hope Scholarship Credit can have been taken for that student for the preceding four years.

Whether you are able to take the American Opportunity Credit depends on the amount of your modified adjusted gross income. If you are married filing jointly, the credit starts to be reduced for incomes above $160,000 and is unavailable to those with an income greater than $180,000. For single filers, the credit is reduced for incomes above $80,000 and is unavailable to single filers with an income greater than $90,000.

One of the other benefits of the American Opportunity Credit is that this is a partially refundable credit. Up to forty percent of the credit (up to $1,000 per student) may be refundable, meaning that if the refundable portion of your credit is more than your tax, the excess will be refunded to you. Other important limitations on the availability of this credit are that the credit is only available for four tax years per eligible student and the student must not have been convicted of a felony for possessing or distributing a controlled substance.

B. Lifetime Learning Credit

The second tax credit available for college and graduate education expenses is the Lifetime Learning Credit. You are able to claim a credit of up to $2,000 for adjusted qualified education expenses paid for each student who qualifies for this credit.

In order to qualify for the Lifetime Learning Credit, the only requirement that must be met is that the qualified education expenses must be paid for the higher education of an eligible student. An eligible student is simply a student who is enrolled in at least one course of study at an eligible education institution. This includes both undergraduate and graduate degree programs and also includes courses to acquire or improve job skills that do not lead to recognized degrees.

The income limitations for the Lifetime Learning Credit are significantly lower than those for the American Opportunity Credit. If you are married filing jointly, the credit starts to be reduced for incomes above $108,000 and is unavailable to those with an income greater than $128,000. For single filers, the credit is reduced for incomes above $54,000 and is unavailable to single filers with an income greater than $64,000. Another drawback of the Lifetime Learning Credit is that it is not a refundable credit; meaning that the whole amount of the credit must be used against your taxes owed to receive the full amount of the benefit.

As previously noted, for each student, you can elect for any year only one of the credits. One of the most important differences between the Lifetime Learning Credit and the American Opportunity Credit is that there is no limit on the number of years for which you can claim the Lifetime Learning Credit, unlike the American Opportunity Credit which is limited to four years, including those for which the Hope Scholarship Credit was taken even if the American Opportunity Credit was not taken in that same year. Additionally, unlike the American Opportunity Credit, felony drug convictions do not make a student ineligible for the credit.

II. Student Loan Interest Deduction

If you have taken out student loans, you may be able to deduct up to $2,500 from your taxable income as an above the line deduction. The loan must have been taken out solely to pay qualified education expenses, which include tuition and fees, room and board, books, supplies, and equipment, and other necessary expenses such as transportation. Furthermore, the expenses must have been paid for within a reasonable period of time before or after the student loan is taken out. The student for whom the loan was taken out must be enrolled at least half time in a program leading to a degree, certificate, or other recognized education credential.

You can continue to take this deduction for interest paid during the remaining period of the student loan after the student is no longer enrolled in the course of study. However, if you are married filing jointly, the deduction starts to be reduced for incomes above $130,000 and is unavailable to those with an income greater than $160,000. For single filers, the deduction is reduced for incomes above $65,000 and is unavailable to single filers with an income greater than $80,000. This deduction cannot be taken if your filing status is married filing separately.

III. Education Savings Program

If you are still saving for your child’s anticipated college expenses, using a qualified tuition program (QTP) or Section 529 Plan should be considered. A QTP is a program set up to allow you to either prepay, or contribute to an account established for paying, a student’s qualified education expenses wherein the funds contributed to the QTP can grow tax free as long as the funds are eventually used to pay for qualified education expenses. There can only be one designated beneficiary of a QTP account. QTP’s are either maintained at an eligible educational institution or are established and maintained by states (or agencies or instrumentalities of a state).

The funds in the QTP must be used at an eligible educational institution, which must require, as a condition of enrollment, both tuition and fees and books, supplies, and equipment. Furthermore, in order to use the QTP funds for room and board expenses, the student must be enrolled at least half time in the program and the room and board expenses cannot exceed: 1) the allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance for a particular academic period and living arrangement of the student; or, 2) the actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Furthermore, assets can be rolled over or transferred from one QTP to another. To qualify as a rollover, the funds must be paid to another QTP within 60 days after the date of the distribution. In addition, there are no income tax consequences if the designated beneficiary of an account is changed to another member of the beneficiary’s family. For instance, if you have funds left over in the QTP for your daughter after she finishes her education, you can change the designated beneficiary of that account to your son without incurring income tax consequences.

Finally, one of the benefits of QTP’s is that they can be used in estate planning because you are permitted to make gifts up to the annual exclusion ($14,000 in 2015) tax free to the QTP. Additionally, you are permitted to make up to five years worth of annual exclusion gifts to the QTP at once if you are trying to reduce your taxable estate more quickly, assuming no other gifts are made to the beneficiary of the QTP in the following five years.

If you have questions about which education credits and deductions you qualify for or have questions about using a QTP to save for college expenses, an experienced tax and Estate Planning Attorney in Philadelphia should be consulted.