Tax Credits and Deductions for a College Education

If you’re a college student, are paying off student loans, or have a child in college in 2016, be sure to look out for education-related tax deduction and credits when you file your taxes next year. The IRS names several available deductions and credits related to college expenses, including student loan interest.

I’ll break down the options, so you can easily see if you’ll qualify for any of these valuable tax breaks.

First, a review

First, let’s look at the difference between a credit and a deduction because these tax breaks are divided into those two main categories.

A tax credit directly reduces the amount of income tax you have to pay. So if you owe the government $1,500 but qualify for a credit of $1,000, you’ll only owe $500. A refundable tax credit could mean the government owes you money. If you owe $1,500 but qualify for a $2,000 refundable credit, you’ll get a $500 check. A nonrefundable credit, on the other hand, will take your tax liability down to $0 but won’t put money back in your pocket.

A tax deduction will reduce your taxable income, which will likely reduce the amount of tax you have to pay, but not on a dollar-for-dollar basis. The actual value of a tax deduction depends on your marginal tax rate. For instance, say you get a $1,000 deduction and are in the 15% tax bracket. In this case, the deduction will reduce your actual taxes paid by $150. If you’re in the 35% tax bracket, that same $1,000 deduction would cut your taxes by $350.

(Note: This is an overly-simplified explanation of tax deductions. But the bottom line to understand is that they don’t directly lower your tax liability, and their actual value varies depending on your tax bracket.)

Education-related credits

Credits are a better way to save than deductions, generally, because they reduce your tax liability dollar-for-dollar. So start by seeing if you qualify for any of these credits. If not, check out the deductions. In some cases, you may be able to claim both types for the best possible tax savings.

American Opportunity Credit

The American Taxpayer Relief Act of 2012 extended the American Opportunity Credit, which was formerly known as the Hope Credit, through December 31, 2017.

  • How it works: The American Opportunity Credit can reduce your tax liability by quite a lot, and many Americans who pay for higher education in 2016 will be eligible for it.
  • Deduction limits: This credit can be used to for a maximum annual credit of $2,500 per eligible student. It’s partially refundable. If the credit brings your taxes owed to $0, you can have 40% of any remaining credit amount up to $1,000 refunded to you.
  • Income limits: To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less (or $160,000 or less for married couples filing jointly). You can receive a reduced amount of the credit if your MAGI is between $80,000 and $90,000 (or between $160,000 and $180,000 for married couples filing jointly). If your MAGI is over $90,000 (or $180,000 for joint filers), you cannot claim the credit at all.
  • How it’s calculated: You can claim 100 percent of your first $2,000 of higher education expenses and 25 percent of the next $2,000. So if your income was less than $80,000 (or $160,000) and you paid $4,000 for one student’s educational expenses, you’ll qualify for the whole $2,500 credit. If your income is higher or your expenses were lower, you may still qualify for some tax credit.
  • Qualified student: This credit can be claimed if a student meets the following criteria:
    • Was (in 2016) enrolled in a post-secondary school (college, university, vocational school, etc.) and was working toward a degree or certification
    • Had not completed four years of post-secondary education by the beginning of 2016
    • Carried at least half the normal course load for at least one academic period in 2016
    • Has not been convicted of a felony drug offense
  • Qualified expenses: This tax credit can be used for certain educational expenses for up to four years of education. The expenses include tuition and fees, as well as books, supplies, and equipment necessary for schooling.
  • It’s refundable: Up to 40 percent of the credit can be given to you, even if your tax liability is $0. So even if you owe very little or nothing, claim this credit if you paid qualified educational expenses in 2016.

Lifetime Learning Credit

The Lifetime Learning Credit is great because it can be claimed for as many years as you have educational expenses. However, you can’t claim both the American Opportunity Credit and the Lifetime Learning Credit for any one student in any one tax year. The American Opportunity Credit is better, so look at it first. But if you’re paying for ongoing college expenses, the Lifetime Learning Credit could be a better fit.

  • How it works: You can claim this credit any number of years and for graduate or professional courses. You also don’t need to meet the half-time enrollment requirement. If you’re going to school to further your current education, in graduate school, or just taking one class a semester, this is the credit for you.
  • Deduction limits: This credit is a non-refundable deduction for up to $2,000. Basically, you can claim 20 percent of up to $10,000 in total educational expenses. If your family has more than one spouse and/or dependent in college in 2016, you can add educational expenses from different individuals together to meet that $10,000 limit. Unlike the American Opportunity Credit, this one is not refundable, so it can take your tax liability to $0, but not put money back into your pocket.
  • Income limits: To qualify for the full credit, your modified adjusted gross income  (MAGI) for 2016 needs to be $55,000 or less ($110,00 or less if filing jointly). For a partial credit, income limits are up to $65,000 ($130,000 if filing jointly). Those with incomes over this limit will not qualify for the credit at all.
  • Qualified student: Even if you only took one class, you can apply for this credit. You can claim the credit as long as you were the one paying the expenses for the student.
  • Qualified expenses: This credit can be used only for tuition and mandatory fees, not for other expenses like room and board or books. However, the credit can be claimed even if you paid for tuition with a student loan.

One thing to keep in mind with these two deductions: You can choose which deduction you take for which students. Let’s say, for example, that your family funds your spouse’s graduate school education, two continuing education courses for yourself, and your child’s undergraduate education in 2016.

If you meet the income limits for the American Opportunity Credit and your child is in her first four years of post-secondary education, you can claim that credit for your child’s expenses. Then, you can add yours and your spouse’s tuition and fees together to claim a deduction for the Lifetime Learning Credit.

If you’re still paying for your child’s education after her first four years, you can’t claim the American Opportunity Credit, but you can claim the Lifetime Learning Credit. To find out if you’re eligible to claim one of these credits, check out the IRS’s calculator.

Education-related deductions

We’ll look at several deductions, some of which you can claim even if you’re a graduate, non-traditional, or part-time student, and others you can claim just for paying student loans or brushing up on career-related knowledge and skills.

Tuition and Fees Deduction

You may be able to deduct certain qualified educational expenses you paid for yourself, your spouse, or a dependent in 2016. This deduction can get a little complicated because “educational expenses” can be interpreted broadly. Here’s what you need to know:

  • How it works: The tuition and fees deduction is claimed using Form 8917, and it’s considered an income adjustment. That means that you can take this deduction even if you take the standard deduction rather than itemizing. (Note: You cannot claim this deduction if you are filing as married filing separately or if another person can claim you as a dependent on his or her tax return for 2016.)
  • Deduction limits: You can use this deduction to reduce your taxable income by up to $4,000.
  • Income limits: You can deduct only tuition and fees for higher education if your modified adjusted gross income (MAGI) is $80,000 or less for single filers or $160,000 or less if you’re filing a joint return.
  • Qualified student: If you paid qualified education expenses for an eligible student, including yourself, your spouse, or your dependent that you claim on your tax return, you can claim those expenses under this deduction. Please note that you cannot double dip on these expenses. In other words, you can’t use the same college expenses to qualify for both the American Opportunity Credit and this deduction. Also, you can only claim dependent expenses if you are the one claiming that dependent for the year. If you and your child’s other parent are divorced and take turns claiming the child as a dependent, you’ll only be able to take this deduction in the years that your child is your dependent tax-wise.
  • Qualified expenses: Qualified expenses are generally any expenses you had to pay to make college happen, including necessary transportation expenses. Obviously, you can deduct tuition and mandatory fees, books, supplies, and other necessary equipment. You can also claim a deduction for expenses paid with a student loan, and for any non-refunded expenses if the student withdraws from classes.

Student Loan Interest Deduction

This is one of the few cases in which you can deduct interest paid on loans. If you pay interest on student loans for yourself, a spouse, or a dependent in 2016, be sure to look into this deduction.

  • How it works: Your student loan company should send you (or give you online access to) a statement showing how much you paid in student loan interest in 2016. If you are paying on student loans through multiple lenders, make sure you get all your statements before filing. This deduction can be used even if you aren’t itemizing your taxes.
  • Deduction limits: The student loan interest deduction can only be used to reduce your taxable income by up to $2,500.
  • Income limits: You can deduct student loan interest if your modified adjusted gross income is less than $80,000 (or $160,000 if you’re filing a joint return) in 2016.
  • Qualified student loan: This deduction works for interest paid on student loans that were used solely to pay for qualified educational expenses (see above for more about qualified expenses). The loan needs to have been for yourself, your spouse, or someone who was a dependent when you took out the loan. In other words, parents/guardians can claim this deduction for interest paid on a student loan used for a child’s educational expenses, even if that child is no longer a dependent.
  • What doesn’t qualify: If you took out a school loan from rich old Aunt Betty, you’re out of luck. Even if you’re paying her back with interest, you can’t deduct interest paid on a loan from a relative. Also, you can’t use this deduction if you’re paying for a student loan through your employer.

Work-Related Education Deduction

If you thought you were out of luck once you finished your bachelor’s and got a full-time job, think again. If you’re planning to itemize your tax deductions, you may be able to use work-related educational expenses to lower your taxable income.

  • How it works: Work-related educational expenses are rolled in with the larger “employee business deduction” category. You can only claim a business deduction, though, for business-related education, job, and certain other expenses that exceed 2% of your adjusted gross income.
  • How to claim it: If you’re employed by someone else, add your qualified education expenses to your other business expenses, and take it as an employee business deduction. If you’re self-employed, qualified educational expenses can be deducted directly from your self-employment income. If you’re employed, you’ll fill out Schedule A on Form 1040 or 1040NR, and if you’re self-employed, you’ll file Schedule C, Schedule C-EZ, or Schedule F.
  • Qualified expenses: Work-related education is only deductible if it is either required by your employer to keep your current salary or job or if it helps you improve or maintain skills that you need in your job right now. Academic, vocational, and refresher courses, as well as some seminars and classes on current developments in your field, could all be fair game.
  • Non-qualified expenses: Educational expenses don’t qualify if you paid for education to meet the bare minimum educational requirements for your job or business, or if the expenses were for an education that will launch you into a new business or career field.

Other ways to save

Whether you paid for a college education in 2012 or not, there are some other ways to cut your tax liability this year and possibly in future years. State-sponsored 529 plans and Coverdell Education Savings Accounts are good ways to grow education savings tax-free until college. Plus, some states allow income tax deductions when you put money into accounts like these.

Speaking of state deductions, it’s important to see if your educational expenses are deductible on your state taxes, whether or not they were deductible on your federal taxes. In New York, for instance, you can deduct a percentage of certain undergraduate expenses – even if you, your spouse or your dependent attended an out-of-state school.

The important thing, when it comes to saving on your taxes, is to check out every possible avenue of savings. Will you qualify for any educational tax credits or deductions this year?

Published or Updated: May 21, 2016
About Abby Hayes

Abby is a freelance journalist who writes on everything from personal finance to health and wellness. She spends her spare time bargain hunting and meal planning for her family of three. She has a B.A. in English Literature from Indiana University–Purdue University Indianapolis, and lives with her husband and children in Indianapolis.

Comments

  1. l. owens says:

    Great info!!!!

  2. Scott says:

    Something to be aware of is the relationship between the AOTC and paying with a 529 or Coverdell. You can’t double-dip and pay for school with tax-free savings and also claim the tax credit. You can, however, use both if the 529 pays for different expenses than you’re claiming with the tax credit. The easiest thing in our situation is that we pay out of pocket for my son’s tuition and books. That easily gets us up to $4,000 to claim for the full AOTC. We use the 529 to pay for housing, which isn’t a qualified expense under the AOTC but IS allowed as a qualified expense by our 529 plan. So we get the best of both breaks.

    On a related note (and of course double-check your specific situation): If you’re a non-traditional student who could qualify for a state tax break by contributing to your state’s 529 plan, you should consider funneling your rent or mortgage through the 529 every month. Pay for your tuition and books to claim the AOTC, and put whatever you pay for your rent or mortgage into the 529, then immediately withdraw it back into your checking account to pay for the qualified expense of room and board. You’ll get a small tax break from the state for doing so.

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