You might not think of the Internal Revenue Service as folks who like to give students a break, but actually there are elements of the tax code that are set up to do just that. Understanding what these tax breaks are and how they work can help you afford college and pay off your student loans faster after graduation.
Just be aware that there are also some common pitfalls that can jeopardize your ability to make the most of your tax breaks. So, it's just as important to know about those pitfalls as about those tax breaks.
Tax breaks for students
Before getting into specific tax breaks, it is best to lead off by explaining the difference between a tax credit and a tax deduction. A tax credit reduces, dollar-for-dollar, the amount of tax you owe, and in some cases may even add to your refund. A tax deduction reduces the amount of your income that is subject to tax.
Generally speaking, a credit is more valuable than a deduction because the entire amount of the credit will affect your tax bill, while with a deduction your tax bill is only reduced by the tax liability on the deductible amount. Also, deductions are generally only available to taxpayers who itemize their deductions.
Here are some specific examples of tax breaks for students:
- American Opportunity Tax Credit (AOTC). This can be claimed by students who are not dependents of another taxpayer, or by taxpayers who are paying qualified education expenses for a dependent. The credit equals 100 percent of the first $2,000 in educational expenses, and 25 percent of the next $2,000. The maximum credit therefore is $2,500, and if this exceeds your tax bill, 40 percent of the remainder will be refunded to you. This credit is available for a student's first four years of higher education.
- Lifetime Learning Credit (LLC). If you incur educational expenses beyond the first four years of college, you may be eligible for a Lifetime Learning Credit. This is a tax credit equal to 20 percent of the first $10,000 you spend each year in college, and there is no limit on the number of years for which this credit can be earned. You cannot claim this credit at the same time as you claim the AOTC, and unlike with the AOTC, any amount of the LLC in excess of your tax bill will not be refunded.
- Tuition and fees deduction. Eligible tuition and academic fees can be deducted from your taxes, but you cannot claim this deduction for amounts used to claim and American Opportunity or Lifetime Learning tax credits. Also, note that these deductions are currently scheduled to expire on December 31, 2017.
- Student loan interest deduction. Up to $2,500 per year in interest paid on a qualifying higher education student loan can be taken as a deduction against interest. As an added plus, you can claim this as a reduction of taxable income even if you don't itemize deductions.
- 529 college savings plans. These provide only a modest tax benefit - contributions to 529 plans are not deductible, but any subsequent investment earnings in the plans are not taxed. There are additional tax consequences if the money in these plans is not used for qualified education expenses, but plan balances can be transferred from one student to another.
Here are some things to be careful of if you want to take advantage of these tax breaks:
- Ineligible programs. Make sure the school you attend has the accreditation necessary for expenses to qualify for education tax breaks.
- Poor documentation. You need clear documentation of what was spent and how it was spent, and in some cases you will need verification from the school.
- Not recognizing income limits. Many of the credits and deductions described above are subject to income limits which can reduce or even eliminate your eligibility for the tax break. These income limits vary from program to program and are subject to change over time, so check the specifics for each tax year.
- Assuming your student days are over. Don't assume that just because you graduated years ago that you can no longer benefit from some of these tax breaks. Some education expenses, including training and certification required for your job, may still qualify you for a tax break.
- Tax law changes. Tax reform is a hot topic right now, so all of these tax breaks are subject to change in the years ahead. Be sure to check with your tax accountant or on IRS.gov each year before you count on a particular tax break.
Paying for college has become a monumental challenge, and one which often sends graduates out into the workplace with a mountain of debt. These tax breaks for students can contribute thousands of dollars towards helping you meet that challenge and cutting your student loan debt down to size. Isn't that worth a little extra time spent getting to know more about the tax breaks the IRS has to offer for you?
- American Opportunity Tax Credit, www.irs.gov, https://www.irs.gov/credits-deductions/individuals/aotc; accessed September 2017
- Education Credits: Questions and Answers, www.irs.gov, https://www.irs.gov/credits-deductions/individuals/education-credits-questions-and-answers, accessed September 2017
- Lifetime Learning Credit, www.irs.gov, https://www.irs.gov/credits-deductions/individuals/llc; accessed September 2017
- Tax Benefits for Education: Information Center, www.irs.gov, https://www.irs.gov/newsroom/tax-benefits-for-education-information-center; accessed September 2017