Education Tax Benefits Can Save Money for Students, Parents
Education tax benefits can take different forms. They can be an tax-saving advantage when you – or your dependent – are in school. Or before college even begins.
Education Tax Benefits – Tax Credits
Tax credits don’t reduce your taxable income – they actually pay taxes for you. There are two main educational tax benefits that take the form of credits. The first is the American Opportunity Credit (AOC).
American Opportunity Credit
Expenses for an eligible student qualify for this credit for the first four years of higher education. Those expenses include books, supplies, and equipment the student needs for a course of study. Room and board – like paying for a dormitory and meal plan – don’t qualify.
Students paying their own tuition – including school costs covered by a loan – can claim the credit. But if others are paying for tuition, and they claim the student as a dependent, they are entitled to take the credit.
In order to be eligible, the student must attend an accepted school offering higher education, such as a college, university or trade school, and be pursuing a degree. The school will send a Form 1098-T showing how much tuition was paid, plus information on any scholarships that reduce tuition costs.
The maximum credit amount is $2,500. The amount of the credit is 100 percent of the first $2,000 of qualified education expenses you paid for each eligible student, and 25 percent of the next $2,000. If the credit reduces your tax to zero, up to 40 percent of the leftover credit is refundable. The AOC is only available for the first four years of post-secondary education.
Lifetime Learning Credit
The Lifetime Learning Credit is another credit available after eligibility for the AOC has run out. It has no limit to the number of years it’s available. The credit’s maximum is $2,000, covering 20 percent of the first $10,000 in expenses.
An importance difference from the AOC – the Lifetime Learning Credit is not refundable. In addition, it can be used in pursuit of a degree, or in taking classes to improve career skills.
Education Tax Benefits – Savings Programs
There are a few types of education savings programs that come with tax advantages. One is the Coverdell Educational Savings Account (ESA). Contributions to an ESA are not deducted from your income, but your investment grows tax-free and distributions can be tax-free as well. The maximum yearly contribution is $2,000.
Qualified Tuition Programs (QTPs), also known as 529 plans, are established at the state level. They let you either prepay or contribute to an account for paying a student’s qualified education expenses at a post-secondary institution. No tax is due on a distribution from a QTP, unless the amount is greater than the student’s qualified education expenses. Qualified expenses include required tuition and fees, books, supplies and equipment.
Links
Publication 970 is the IRS’s guide to educational tax benefits.
Check out our earlier blog post to learn more about Washington state’s 529 plans.
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