Summer is coming to a close and back-to-school preparation is upon us. For parents of younger children, this shift often means the return to a peaceful lifestyle, free of the headaches associated with finding full-time childcare. However, for the parents of many recent high school graduates, this is the time where headaches increase, as they send their children off to college, prepare their teens to leave home for the first time, and – perhaps the most stressful part of all – determine how to pay for it all.
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If your child (or even you or your spouse) is enrolled in a college, university or other post secondary educational institution, the American Opportunity Tax Credit, the Lifetime Learning Credit and the Tuition and Fees Tax Deduction can all help reduce education costs. With the rising cost of higher education, it is becoming more crucial than ever to take advantage of any and all available tax breaks when it comes to financing and obtaining a college degree. If you are paying tuition and other qualified expenses from your savings or from a loan for either your yourself, your spouse or your child (whom you must claim as a dependent on your tax return), read on to learn about the three education tax breaks that you may be able to leverage. Furthermore, in order to ensure proper tax planning and to leverage the education tax break that will yield the lowest tax, it is important to understand the details of each tax break as well as the differences among them.
The American Opportunity Tax Credit (AOTC), formerly called the Hope Credit, has been put in place to help alleviate some of the financial burden that — for most people — is par for the course when it comes to paying for a college education. The AOTC is available to individuals who are enrolled at least half-time in a qualified or accredited higher education institute (verify here), with the intended result being to earn a college degree.
The AOTC can be received for the first four years in which an individual is enrolled – which includes any years in which the Hope Credit was claimed — and the maximum credit allowed per calendar year is $2,500 for each qualified student. Moreover, up to 40% of the credit is refundable, meaning that even if your tax liabilities are less than the credit, you can still get money back. Realize that this credit cannot be claimed in combination with the Lifetime Learning credit for the same student in the same year.
According to the IRS website, expenses that qualify for the tax credit are rather specific. Eligible education expenses include tuition, required enrollment fees, books, supplies and equipment. Computers may qualify if having one is required by the educational institution.
On the other hand, ineligible expenses include such costs as room and board, transportation, medical expenses and other types of insurance. It is also important to be aware that for expenses to quality they must have been paid out either during 2011 or within the first three months of 2012.
In addition to the aforementioned criteria, you must also meet certain income requirements in order to claim the AOTC. You will not qualify for the AOTC if you are married and file separately or if you have an adjusted gross income (AGI) of $90k or more ($180k if married filing jointly). The credit is reduced or begins to phase out at an AGI of $80k a year if filing single ($160k a year if married filing jointly).
The Lifetime Learning Tax Credit (LLTC) is another tax credit available to help reduce the cost of sending your child, your spouse or yourself to college. The LLTC can also be used for graduate school as well as educational courses taken simply to improve upon one’s job skills. Moreover, the credit can be claimed for an unlimited number of tax years.
Unfortunately, the Lifetime Learning Tax Credit is non-refundable and is capped at $2,000 per tax return. Also, this credit cannot be claimed in combination with the AOTC for the same student in the same year.
Eligible expenses and ineligible expenses are similar to those of the AOTC, but with two major exceptions. First, since the LLTC can be applied toward job improvement courses, any course of instruction that is related to sports, games or hobbies, that does not improve job skills or that is not part of a degree program does not qualify. Second, books and materials that are not mandatory for enrollment (regardless of where they are purchased) are not qualified expenses.
Income limitations for the LLTC are much more restricting than those of the AOTC. For single filers ho have an AGI between $50k-$60k (or joint returns between $100k-$120k), the credit is reduced or begins to phase out. Moreover, if you are filing as single and have an AGI greater than $60,000 ($120,000 if married filing jointly), you will not be able to claim this credit at all.
Unlike the LLTC and AOTC, the Tuition and Fees Tax Deduction (TFD) will not directly lower your taxes dollar-for-dollar. Since this tax benefit is a tax deduction and not a tax credit, it will have a smaller impact in terms of lowering your taxes. The annual deduction amount is up to $4k per year for qualified expenses that you pay for yourself, your spouse or your child (as long as that child is a dependent). The good news is that it is an above-the-line tax deduction, meaning that you do not need to itemize in order to claim this deduction unless you claim the expenses as a business expense. Furtheremore, you cannot claim this deduction if you have already claimed an education tax credit for that student’s expenses in the same year.
Eligible expenses are generally limited to tuition and enrollment fees. Ineligible expenses include any costs – such as books, materials, room and board, health fees, insurance, transportation and equipment – that are not required as a condition of enrollment or attendance. Furthermore, educational expenses that were paid with a scholarship, fellowship or funds from your employer must be subtracted. Finally, any expenses paid with tax-free savings bonds, 529 plans or Coverdell accounts cannot be deducted.
Similar to the previously discussed education tax credits, there are income limitations that restrict who qualifies for this education tax deduction. If your AGI is greater than $80,000 ($160,000 if married filing jointly), you will not be able to claim this deduction. Moreover, if your AGI is between $65k-$80k ($130k-$160k for joint returns, the credit is reduced to $2k).
Although the American Opportunity Tax Credit will likely be the preferred education tax break through 2012, that does not necessarily mean that it will be the most beneficial option for your unique situation. Therefore, it is highly recommended that you figure out whether you qualify for any other education tax breaks in 2011. Knowing all of your options will help you determine the educational tax break that will result in the lowest tax liability.
If you are still unsure as to which educational tax break you are eligible for, or are unable to determine the option that is best for you, take a look at this helpful comparative breakdown:
| AOTC | LLTC | TFD | |
|---|---|---|---|
| Tax Benefit Type |
Tax Credit
|
Tax Credit
|
Tax Deduction
|
| Refundable? |
No
|
Up to 40%
|
Not Applicable
|
| Student Required to Seek Degree? |
Yes
|
No
|
No
|
| Income Level Cap |
$180k if married filing jointly, $90k if filing single
|
$120k if married filing jointly, $60k if filing single
|
$160k if married filing jointly, $80k if filing single
|
| Tax Benefit Phase-Out Range |
$80k to $90k
|
$50k to $60k
|
$65k to 80k
|
| Tax Benefit Limit |
$2,500 per eligible student
|
$2,000 per tax return
|
$4,000 per tax return
|
| Applicable Academic Periods for Payments |
Payments made for academic period in 2011 and the first 3 months of 2012
|
Payments made for academic period in 2011 and the first 3 months of 2012
|
Payments made for academic period in 2011 and the first 3 months of 2012
|
| Applicable Education |
First 4 years of undergraduate education
|
Undergraduate, Graduate & Job Improvement or Skill Acquisition Courses
|
Undergraduate & Graduate Education
|
| Qualifying Expenses |
Tuition, enrollment fees, books, supplies & equipment
|
Tuition & enrollment fees; Books & materials may qualify if required for enrollment or attendance at institution
|
Tuition & enrollment fees; Books & materials may qualify if required for enrollment or attendance at institution
|
| Minimum Enrollment Level |
Enrolled at least half-time for one academic period that starts during tax year
|
None
|
None
|
| Filing Status Limitation |
Cannot be married filing separately
|
Cannot be married filing separately
|
Cannot be married filing separately
|
| Felony Drug Conviction Limitation |
Yes
|
No
|
No
|
This article is simply a guide, so be sure to review IRS Publication 970 for complete details. The IRS (www.irs.gov) also provides easy-to-use worksheets to help you calculate your potential tax liability with each of these education tax breaks.
When in doubt, it is in your best interest to contact a tax professional — such as an enrolled agent, CPA or licensed tax preparer — before filing your taxes or making a final decision as to which educational tax benefit is best for you.
Pinyo I have to say this article was useful. Thanks! It is so hard to figure out with our complex tax system what educational tax benefit my wife qualifies for with her continuing education.
@John – Thank you. I appreciate the feedback.