There are several tax incentives for higher education expenses that are available to taxpayers of various income levels. We have summarized a few incentives available which we see with our clients most often below:
The American Opportunity Credit:
Calculation of Credit: The American Opportunity Credit allows for a maximum annual credit of $2,500 per individual for the first four years of post-secondary education. The credit equals $100% of the first $2,000 of a student’s qualified education expenses plus 25% of the next $2,000. 40% of the total credit (up to $1,000) is refundable. The credit must be claimed on the individual’s return who claims the student, regardless of who pays the expenses.
Covered Expenses: Expenses eligible for the credit include tuition, mandatory enrollment fees, and cost of books and course materials directly related to enrollment at an eligible institution. Expenses such as room and board, and optional expenses such as student health insurance and athletic fees do not qualify for the credit.
Income Limitations: To claim the full credit your modified adjusted gross income (MAGI) must be $80,000 or less for a single taxpayer, or $160,000 or less if married filing jointly. Single taxpayers with MAGI between $80,000 and $90,000 and married couples with MAGI between $160,000 and $180,000 can claim a reduced amount of the credit. If your income is above the upper threshold, the credit is disallowed. Those who use married filing separate status are not eligible for the credit regardless of income.
Lifetime Learning Credit:
Calculation of Credit: The Lifetime Learning Credit is 20% of up to $10,000 of qualified education expenses, which include payments made for undergraduate studies not covered by the American Opportunity Credit, graduate school, and courses taken to maintain or improve job skills. The maximum credit is $2,000 per household. The credit must be claimed on the individual’s return who claims the student, regardless of who pays the expenses.
Covered Expenses: Expenses eligible for the credit include tuition, mandatory enrollment fees, and cost of books and course materials directly related to enrollment at an eligible institution. Expenses such as room and board, and optional expenses such as student health insurance and athletic fees do not qualify for the credit.
Income Limitations: To claim the full credit your modified adjusted gross income (MAGI) must be $59,000 or less for a single taxpayer, or $113,000 or less if married filing jointly. Single taxpayers with MAGI between $59,000 and $68,000 and married couples with MAGI between $118,000 and $136,000 can claim a reduced amount of the credit. If your income is above the upper threshold, the credit is disallowed. Those who use married filing separate status are not eligible for the credit regardless of income.
Tuition and Fees Deduction:
Calculation of Deduction: A maximum of $4,000 of qualified education expenses can be taken as an above-the-line deduction (before calculating adjusted gross income).
Covered Expenses: Expenses eligible for the deduction include tuition, mandatory enrollment fees, and cost of books and course materials directly related to enrollment at an eligible institution. Expenses such as room and board, and optional expenses such as student health insurance do not qualify for the credit.
Income Limitations: To claim the full credit your modified adjusted gross income (MAGI) must be $65,000 or less for a single taxpayer, or $130,000 or less if married filing jointly. Single taxpayers with MAGI between $65,000 and $80,000 and married couples with MAGI between $130,000 and $160,000 can claim a reduced deduction of $2,000. If your income is above the upper threshold, the deduction is disallowed. Those who use married filing separate status are not eligible for the credit regardless of income.
Double Dipping Rules:
While there are multiple credits and deductions available for education expenses, it is important to note that the IRS does not allow for double dipping of the tax benefits associated with education expenses. If you claim one credit or deduction, you are not able to claim another. Because of this, we always ensure that the credit or deduction we are taking for our clients, yields their highest total tax benefit.
Additionally, if you withdraw funds from a 529 college savings plan, the earnings associated with the distribution are generally tax free as long as the funds are used to pay eligible education expenses. However, the expenses that are used to benefit from the credit cannot also be used to as eligible expenses when determining the amount of taxable earnings.
Please contact a member of the Waterford Advisors team if you have any questions regarding the provisions detailed above.