Tax Breaks For College Costs

Persistently increasing college costs may have joined death and taxes as inevitable facts of life. Still, it is usually possible to soften the blow of escalating costs of higher education by taking advantage of an assortment of income tax breaks provided by the federal government. The options and their ramifications for your tax bill are not as simple as they might be, so it may be prudent to get some professional advice. Given the large sums of money at stake, you do not want to leave any smart moves unmade for lack of information and timely advice.

American Opportunity Tax Credit
This year, the American Opportunity Tax Credit effectively replaces the Hope Scholarship Credit. Taxpayers spending at least $2,000 for tuition, fees, books, and materials for higher education can save $2,000 in taxes with a dollar-for-dollar credit. Expenses over $2,000 bring an additional tax credit of 25 cents on the dollar, and, if expenses reach $4,000, there is a maximum credit of $2,500. The credit is available per student, so that a family with more than one college student can achieve even larger total benefits. Up to 40% of the American Opportunity Tax Credit is refundable, so that some of the tax credit may be received as a tax refund if the credit for which the taxpayer qualifies exceeds his or her income tax liability. This credit phases out for taxpayers with a modified adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 for married couples filing jointly).

Lifetime Learning Credit
While the American Opportunity Tax Credit is limited to the first four years of education after high school, the Lifetime Learning Credit, as the name suggests, may be claimed for any year of higher education, such as years spent in graduate or professional schools. Another distinction between the two credits is that the Lifetime Learning Credit is available for any course of study relating to job skills at an accredited school, whereas the American Opportunity Tax Credit requires that the student be enrolled at least on a half-time basis. The phaseout income ranges are lower than for the American Opportunity Tax Credit, by margins of $30,000 for individuals and $60,000 for married couples filing jointly.

Calculated at 20 cents on the dollar, the Lifetime Learning Credit maxes out at $2,000 for $10,000 in tuition and related expenses. It is not refundable. Unlike the American Opportunity Tax Credit, which is determined per student, the Lifetime Learning Credit is calculated per taxpayer, so that any one taxpayer has the above maximum no matter how many individuals in a family are studying at the postsecondary level. A taxpayer may not use both credits for the same student in the same year, but different credits may be used for different students' expenses in the same year.

Tuition and Fees Deduction
A tax credit, by shaving off the actual tax bill, does more for a taxpayer's bottom line than a deduction, which only reduces the income on which the tax will be imposed. Still, there is a third option in the form of a tax deduction for tuition and related fees, although it cannot be used in the same year for the same student as either of the tax credits previously described. This deduction, which is available even for taxpayers who do not itemize deductions, can be as large as $4,000 for modified adjusted gross incomes up to $65,000 ($130,000 for married couples filing jointly). The deduction is cut in half for even one dollar above those incomes, and disappears altogether when the income levels top $80,000 ($160,000 for married couples filing jointly). Another limitation on this deduction is that it cannot be claimed for expenses paid with money from a Section 529 plan or withdrawals from a Coverdell Education Savings Account.

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