The education of
your children, or even of yourself and your spouse, can be a major investment.
Knowing if your college-age child is still a dependent, what scholarships are
taxable, and which tax credits are available can be confusing. You need to
consider your situation to determine which options are best for you. Tax
planning is essential to make the most of these benefits. You need to know
which one of the options are best for you based on your income the varying
definition of allowable expenses. You should also consider issues such as the
student's eligibility for financial aid and who has control over the money used
for college. In certain circumstances, it might be better to have the child
pay the education expenses rather than the parent.
Keep the following in
mind when determining the best way to claim a tax break for education:
- Is the student a dependent?
- Does the student have any
Scholarships or Grants?
- Did you pay any student loan interest?
- Does the student have a Coverdell Education Savings Account?
the student have a Qualified Tuition Program?
- What are the Education
- Does the student have eligible savings bonds?
Whether a student is claimed as a dependent on your tax
return may affect yours, or the student's eligibility, for the different tax
benefits available for education expenses.
A student is someone enrolled
in school full-time for at least five months out of the calendar year. A
full-time student under age 24 who has a job may still be claimed as a
dependent on their parents' return.
Scholarships and Grants
a student is a candidate for a degree, they can exclude from income the amount
of scholarship or grant used for tuition, books, and fees. The amount of the
scholarship or grant that is used for room and board or for teaching or
research is considered taxable income even if the teaching or research is a
condition for receiving the scholarship or grant.
Students who win a
scholarship prize in a contest must include the amount as prize winnings on
their tax return unless the prize is designated to be used for educational
Payments, or scholarships received from the Department of
Veterans Affairs, National Health Services Corps Scholarship Programs or by the
Armed Forces Health Professions Scholarship and Financial Assistance Program are
not included in income.
Student Loan Interest Deduction
You may be able to deduct up to $2,500 of interest you paid on a qualified
student loan to attend an accredited, higher educational institution. The loan
must have been for you, your spouse, or someone you claimed as your dependent
when you took out the loan. This deduction is an adjustment to income so you
can claim it even if you do not itemize deductions on Schedule A, Itemized
Deductions. Your modified adjusted gross income must be less than $75,000
($150,000 if Married Filing Jointly). If you are filing Married Filing
Separately, you cannot take this deduction.
Savings Account (ESA)
The Coverdell Education Savings Account
(Coverdell ESA) is an account for the sole purpose of paying for the qualified
education expenses of the designated beneficiary of the account.
beneficiary can use the funds in the Coverdell ESA to pay for their qualified
expenses of attending a public, private, or religious school at the elementary,
secondary or higher education levels. Qualified expenses include books,
tutoring, computer equipment, software and services, room and board, uniforms,
extended-day program costs, and the expenses of an individual with special
needs that are necessary for that person's enrollment or attendance at an
eligible educational institution.
Anyone, including the beneficiary, can
establish and contribute to this account but contributions can not exceed
$2,000 per year, per beneficiary. You can make a contribution to a Coverdell
ESA if your modified adjusted gross income for the year is less than $110,000
($220,000 if Married Filing Jointly). If your modified adjusted gross income
is above the limit, it is possible for you to provide the beneficiary with the
money as a gift and have the beneficiary make the contribution on their own
behalf, as long as the beneficiary's income is not over the limit. No
contributions can be made to the account once the beneficiary turns age 18,
unless the beneficiary is an individual with special needs.
contributions are not tax deductible but earnings are tax free to the
beneficiary if they are used to pay for qualified education expenses. A 10%
penalty may apply to a distribution that is not applied to qualified education
expenses. Money remaining in the account after a beneficiary is no longer in
school can be rolled into another family member's Coverdell ESA account tax
free if certain conditions are met.
Contributions to a Coverdell ESA are
considered a gift from the contributor to the beneficiary and are eligible for
the annual gift tax exclusion.
Qualified Tuition Program (QTP)
Qualified Tuition Program (QTP or Section 529 plan) is a program that allows
you to prepay a student's college tuition or contribute to a higher education
savings account for payment of qualified higher education expenses. Qualified
expenses include books, supplies, equipment, and room and board if the student
is attending at least half-time. Half-time attendance is defined by the
institution. Plans can be established by a state agency or by a qualified
educational institution. You are not restricted to investing in your state's
plan, but contributions to your own state's plan may qualify you for certain
additional tax benefits on your state tax return.
Contributions to a QTP
are not tax deductible. If not used for qualified educational
expenses, distributions may be subject to a 10% additional tax. Money
remaining in the account after paying for a beneficiary's qualified expenses
can be rolled into another family member's QTP account tax free if certain
conditions are met.
Contributions to a QTP are also considered a gift
from the contributor to the beneficiary and are eligible for the annual gift
You can contribute to both a QTP and a Coverdell
education savings account in the same year for the same beneficiary.
Higher Education Credits
The following two tax credits are
available to taxpayers who pay higher education costs:
- The American
Opportunity Credit - Available through 2017
- The Lifetime Learning
The American Opportunity Credit is a credit of up to $2,500
for the qualified tuition and related expenses paid for each eligible student.
The credit is 100% of the first $2,000 of qualified expenses plus 25% of the
next $2,000 of qualified expenses paid per student. It can be claimed for the
first four years of postsecondary education for each student. The student must
be enrolled at least half time in a qualified program and must not have been
convicted of a felony drug offense. Eligible expenses include tuition,
required fees, and the cost of required books and software for courses.
You do not qualify for the credit if your modified adjusted gross income is
greater than $90,000 or $180,000 if married filing jointly.
Opportunity Credit is unique in the fact that it combines both a nonrefundable
and a refundable credit in one. The first 40% of the credit up to $1,000 is
refundable with the balance of the credit treated as a nonrefundable credit.
This unique feature allows you to receive the refundable portion of the credit
as a refund if you have no remaining taxes.
You may be able to claim a
Lifetime Learning Credit of up to $2,000 each year for the total qualified
tuition and related expenses paid during the tax year for all eligible
students who are enrolled in eligible educational institutions. This credit is
20% of the first $10,000 of qualified expenses paid per tax return. Unlike the
American Opportunity Credit, the Lifetime Learning Credit is not based on the
student's workload and is not limited to the first two years of postsecondary
education. Expenses for graduate-level degree work are eligible. You do not
qualify for the credit if your income is greater than $64,000 ($128,000 if
Married Filing Jointly). The Lifetime Learning Credit is a nonrefundable
credit. This means that if your taxes are less than your credit, then you will
lose any remaining credit amount left after you reduce your income taxes to
You do not qualify for either credit if your filing status is
Married Filing Separately. In addition, you cannot claim both the American
Opportunity Credit or the Lifetime Learning Credit for a student in the same
You must claim the student as a dependent to receive either education
credit. If you do not claim the student as a dependent, or if someone else is
eligible to claim the student as a dependent but elects not to, only the
student may claim the credit. A student claimed as a dependent on another
person's tax return cannot claim the credit. Claiming the American Opportunity
Credit may be more beneficial than claiming the Lifetime Learning Credit, if
you are eligible for both.
For example, Brad's filing status is Single,
and he has wages of $31,000. After allowing for the standard deduction and
personal exemption amount, his tax is $2,678. He is a sophomore in college and
paid $10,000 in qualified tuition expenses during the year as part of a degree
program. He has no other income or deductions. Brad has the choice of taking
the American Opportunity Credit or the Lifetime Learning Credit. He should
choose whichever option gives him the biggest tax savings:
takes the Lifetime Learning Credit instead, he would save $2,000 in taxes (the
maximum credit amount) because his income is below the limits.
- If Brad
takes the American Opportunity Credit instead, he would save $2,500 in taxes
(the maximum credit allowed) because his income is below the limits.
The American Opportunity credit gives him $500 more in tax savings
than the Lifetime Learning credit would.
Brad should claim the American
Opportunity Credit for the best bottom line on his tax return.
Education Savings Bond Program
You may exclude interest on
qualified U. S. savings bonds from your gross income if you have paid
qualified higher educational expenses during the redemption year. When
calculating the amount of higher education expenses paid during the year, you
may include any contribution of the bond proceeds to a QTP and any
contribution to a Coverdell ESA as a qualified expense. You do not qualify for
the exclusion if your filing status is Married Filing Separately or if your
modified adjusted gross income is greater than $91,000 ($143,950 if Married
Filing Jointly) in the year the bond is redeemed.
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