If you have a child in college, do you qualify for a federal tax credit or tax deduction?
These are valuable tax benefits that can help you defray the rising cost of a college degree and yet some parents have no idea that they exist or whether they would qualify.
American Opportunity Tax Credit
For eligible parents, the best federal tax credit is the American Opportunity Tax Credit. Over the course of their children’s college years, parents can claim up to a total of $10,000 in tax credits per child.
Tax credits are far more valuable than tax deductions because they reduce a tax bill dollar-for-dollar.
With the American Opportunity Tax Credit, parents can claim a maximum $2,500 tax credit for each child in college. So eligible parents would be able to claim $5,000 in tax credits with two college-going students.
If the amount of the American Opportunity Tax Credit for which parents are eligible exceed their tax liability, the excess would be refunded up to the lesser of 40 percent of the credit or $1,000.
How to Qualify for the Tax Credit
Taxpayers will capture 100% of the first $2,000 they spend on qualified college expenses for a student and 25% on the next $2,000 spent. Tuition and fees and course materials such as textbooks, supplies and equipment are eligible expenses.
The following expenses do not qualify for the credit:
- Room and board.
- Medical expenses.
Parents can use this credit for no more than four years of college for each child.
Wealthier parents are prohibited from capturing the AOTC because of a tax cutoff that includes a phase-out. Married couples making $160,000 or less in modified adjusted gross income are eligible for the full tax credit. Single individuals with a modified adjusted gross income of $80,000 or less would qualify for the full tax credit.
With the phase-out, a single taxpayer making more than $90,000 MAGI and joint filers making more than $180,000 MAGI can’t claim the credit.
To qualify, students must be enrolled at least part-time and seeking a degree or certificate. To capture the tax credits, your clients must be able to claim an exemption for the student on the taxpayer’s income tax return.
The American Opportunity Tax Credit has been on the verge of disappearing more than once because it requires Congressional reauthorization. Currently, the tax credit will be available through tax year 2017.
Lifetime Learning Tax Credit
In general, the AOTC will be the most attractive tax credit, but it is only available for four years and many undergrads take longer than that to complete college. The Lifetime Learning Tax Credit isn’t constrained by this time limit.
The Lifetime Learning Tax Credit is popular with students in graduate and professional schools.Students who are convicted of a felony drug offense are also eligible for the Lifetime Learning Tax Credit, but not the AOTC.
With this credit, taxpayers can claim up to a $2,000 tax credit on their federal income tax return that is based on the first $10,000 in tuition and required fees. Your clients cannot claim this credit for each child in college. Only one credit can be claimed each year regardless of how many are in college.
Room and board, insurance, medical expenses and transportation are not eligible expenses.
No Double Dipping
What’s tricky about using both of these higher-ed tax credits is that no double dipping is allowed. Parents can’t use the same educational expenses to qualify for more than one education tax benefit and that includes tax-free withdrawals from a 529-college savings account. Those tax-free withdrawals are considered an educational benefit.
Consequently, to use $4,000 in eligible expenses to capture the full AOTC, you need to have this amount of expenses that weren’t covered by 592 account withdrawals.
So when parents claim the AOTC or the Lifetime Learning Tax Credit, they need to make sure that they aren’t using the same expenses twice.
Example No. 1:
Parents withdraw $5,000 from a 529 plan to help pay for college tuition. They spend a total of $7,000 to cover their child’s qualified expenses at a local state university. They wouldn’t be able to claim the full AOTC because $4,000 in expenses were covered by 529 plan withdrawals. After subtracting that $4,000, there is only $3,000 left to claim the AOTC. This family would get a partial tax credit.
Example No. 2:
Parents withdraw $10,000 from a 529 plan to pay for college expenses and they spent an additional $30,000 to pay for eligible expenses at a pricey private college. The family needed to spend only $4,000 beyond the initial $4,000 withdrawal in a 529. They spent $36,000 so they had well over the expenditures needed to capture the full AOTC.
Learning More About College Tax Credits
You have always been able to read about these higher-ed tax benefits on the IRS website or through IRS Publication 970, but when you finish you are likely to be scratching your head about which one to pick and the best way to use them. That’s why I particularly like the Edvisor Network’s tax benefit section entitled, Picking the Best Mix of Education Tax Credits and Deductions