Tax Topics

Jackson Hewitt® is here to help you understand complex tax laws so you can be better informed and take full advantage of tax law provisions.

These topics explore some of the more important aspects of complicated tax laws, in a manner that is understandable and concise.


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Education Credits and Deductions

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 should determine whether your adjusted gross income disqualifies you from using one of the options or whether your education expenses qualify for the benefit you are considering. The definition of qualified educational expenses often differs between the different tax saving options. You should also consider issues other than tax, for example, 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; in other circumstances, it might be better to have the parent pay the education expenses for the student.

Keep the following in mind when preparing your tax return:

  • Dependents
  • Scholarships and Grants
  • Student Loan Interest Deduction
  • Tuition and Fees Deduction
  • Coverdell Education Savings Account
  • Qualified Tuition Programs
  • Higher Education Credits
  • Education Savings Bond Program

Dependents

Whether a student is claimed as a dependent on your tax return may affect your eligibility, 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. If your child must file a return, they cannot claim their own exemption if they qualify as your dependent.

Students are allowed to take the standard deduction even if they are not claiming their own exemption. The standard deduction amount of a dependent may be lower than the standard deduction of a person who is not a dependent.

Scholarships and Grants

A candidate for a degree can exclude from income amounts received for tuition, books, and fees. Amounts used for room and board do not qualify for exclusion.

Amounts received by a scholarship candidate for services such as teaching or research are taxable income even if providing such services is a required condition for receiving the scholarship or grant.

Scholarship prizes won in a contest are not considered scholarships/fellowships if they are not designated to be used for educational purposes only. These must be included in gross income.

Payments from the Department of Veterans Affairs are not considered scholarships and are not included in income.

Scholarship and fellowship payments for teaching, research, or other services paid by the 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.

Tuition and Fees Deduction

You may be able to deduct up to $4,000 for qualified tuition and fees paid for higher education even if you do not itemize deductions. Qualified tuition and fees are amounts paid for you, your spouse, or a person whom you claim as your dependent. The tuition and fees must be required for enrollment or attendance at an eligible educational institution. You may qualify for the maximum $4,000 tuition and fees deduction if your modified adjusted gross income is $65,000 or less ($130,000 or less if Married Filing Jointly) or a reduced tuition and fees deduction of up to $2,000 if your modified adjusted gross income is greater than $65,000 ($130,000 if Married Filing Jointly) but not more than $80,000 ($160,000 if Married Filing Jointly). If your modified adjusted gross income is greater than $80,000 ($160,000 if Married Filing Jointly), you cannot take this deduction.

This deduction is not available:

  • If the American Opportunity Credit or Lifetime Learning Credit is claimed for the student
  • On returns filed with a Married Filing Separately filing status
  • To a person who can be claimed as a dependent on another person's return, even if the other person chooses not to claim the person as a dependent

Qualified expenses used to take the tuition and fees deduction must be reduced by any tax-free benefits received, such as distribution of earnings from a Qualified Tuition Program (QTP) or tax-free savings bond interest. Qualified expenses must also be reduced by the full amount of a Coverdell Education Savings Account (Coverdell ESA) distribution.

For example, Charmaine's modified adjusted gross income is under $65,000. She incurred qualified tuition expenses of $5,000 for her son, Anwar, who is a student Charmaine claims as her dependent. Anwar received a $6,000 distribution as the beneficiary of a QTP, of which $500 represents the tax-free earnings. He also received a $1,000 distribution from a Coverdell ESA. Charmaine's allowable tuition and fees deduction is $3,500 ($5,000 qualifying expenses less $500 tax-free earnings less $1,000 Coverdell ESA distribution).

Coverdell Education Savings Account (ESA)

The Coverdell Education Savings Account (Coverdell ESA) is a custodial or trust account for the sole purpose of paying for the qualified education expenses of the designated beneficiary. The designated beneficiary is considered the owner of the account, which may affect the beneficiary's eligibility for financial aid. The designated beneficiary assumes control of the account upon turning age 18.

In addition to higher education expenses, qualified expenses include certain elementary (including kindergarten) and secondary public, private, or religious school tuition and expenses. 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. However, if the beneficiary is under age 18, the parent or guardian of the beneficiary must set up this account. 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 modified adjusted gross income is not over the limit. The maximum total of all contributions for any one beneficiary cannot be more than $2,000 per tax year. No additional contributions can be made to the account once the beneficiary turns age 18, unless the beneficiary is an individual with special needs.

The 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 paying for a beneficiary's qualified expenses 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)

A 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.

You may make nondeductible contributions to a QTP for yourself or for any other beneficiary, regardless of your relationship to the beneficiary. There are no age restrictions and no income restrictions on the individuals contributing to the plan.

Contributions are not tax deductible. The part of a distribution representing the amount contributed to a QTP is not included in income. Earnings distributed by a QTP are not included in income if the total distribution is used to pay qualified education expenses. This exclusion from income applies to distributions from QTPs established and maintained by private colleges and universities. Previously, only distributions from programs established by a state agency qualified for this exclusion. A 10% penalty may apply to the taxable part of the distribution.

A QTP is not a custodial account; therefore, the beneficiary is not considered the owner of the account. The parent, as the account holder, is able to change the designated beneficiary at will. For example, if the current beneficiary obtains a scholarship and no longer needs the money, the account holder can assign a new beneficiary. 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 tax exclusion.

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 Credit

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.

The American 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 $62,000 ($124,000 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 taxes to zero.

Both of these credits are nonrefundable and may be reduced based on your income. You may claim the American Opportunity Credit for any of the first four years of a student's postsecondary education and claim the Lifetime Learning Credit for that same student in later tax years. You can claim the American Opportunity Credit for one child and the Lifetime Learning Credit for another student in the same tax year. College students who pay expenses using a Coverdell Education Savings Account (Coverdell ESA), a Qualified Tuition Program (QTP), or education savings bond funds may also claim an education credit if the expenses used for the credit are different expenses than those paid with distributions from these funds.

You do not qualify for either credit if your filing status is Married Filing Separately. In addition, you cannot claim either the American Opportunity Credit or the Lifetime Learning Credit for a student in the same year you are claiming the tuition and fees deduction for that student. 
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. Also, claiming one of the education credits is usually more beneficial than taking the tuition and fees deduction because a credit offsets the tax liability dollar for dollar. However, if you do not qualify for any of the education credits (for example, because of modified adjusted gross income restrictions) you may instead decide to take the tuition and fees deduction on your return.

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 $2,756. 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, the Lifetime Learning Credit, or the tuition and fees deduction. He should choose whichever option gives him the biggest tax savings:

If Brad takes the tuition and fees deduction, which allows a maximum deduction of $4,000, he would save $600 in taxes ($4,000 x 15% tax bracket). 
If Brad takes the Lifetime Learning Credit instead, he would save $2,000 in taxes (the maximum credit amount) because his income is below the limits. In this scenario, the credit gives you $1,400 more in savings than the tuition and fees deduction would. 
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. In this scenario, the credit gives him $1,900 more in savings than the deduction would.

The maximum allowable American Opportunity Credit is $2,500 per student. The maximum allowable Lifetime Learning Credit is $2,000 per tax return. In the preceding scenario, if Brad's education expenses had been $7,000, the American Opportunity Credit would save $1,100 more in taxes than the Lifetime Learning Credit. The American Opportunity Credit would still be $2,500, but the Lifetime Learning Credit would only be $1,400 ($7,000 expenses x 20% Lifetime Learning Credit rate).

If your income level disqualifies you from using the Lifetime Learning Credit, you might still be able to take the American Opportunity Credit or the tuition and fees deduction. In the preceding scenario, had Brad's income been $63,000, he would not qualify for the Lifetime Learning Credit (the modified adjusted gross income limit for credit is $62,000 for Single filers). He is still eligible for the American Opportunity Credit of $2,500. He is also eligible for the tuition and fees and deduction. If he chooses the tuition and fees deduction, he could claim a $2,000 tuition and fees deduction and, if he takes the standard deduction, realize a tax savings of up to $500 ($2,000 x 25% tax bracket).

As shown in these scenarios, it pays to be aware of the different rules.

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 Qualified Tuition Program (QTP) and any contribution to a Coverdell Education Savings Account (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 $87,850 ($139,250 if Married Filing Jointly) in the year the bond is redeemed.

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