College

Tax Breaks for College Costs

College is expensive. Take advantage of tax breaks to ease the financial pain.

By the Editors of Kiplinger's Personal Finance Magazine

June 2010

The big day has finally arrived. Your son or daughter applied to colleges, sifted through the acceptance letters and decided where to spend the next four (or five or more) years. Now all you have to do is figure out how to pay for it. Luckily, Uncle Sam offers several ways to ease the sting of rising tuition costs. Which tax breaks work for you will depend on your income, your child's student status and the source of your education funding.

American Opportunity Credit. This credit is available for expenses incurred by students who attend college at least half-time during their first four years of undergraduate education. It replaces (at least temporarily)—and improves upon—the Hope credit, which was available for only the first two years of higher education. (A tax credit is a dollar-for-dollar reduction of your tax liability.) It will be in effect at least through 2010. An enhanced Hope credit was available through 2009 for students who attended college in a midwestern disaster area (see Publication 970 at www.irs.gov).

A parent, spouse or student who is not claimed as a dependent can take a federal income-tax credit equal to 100% of the first $2,000 spent on qualified education expenses—tuition, fees and textbooks—and 25% of the next $2,000, for a total credit of $2,500 for each qualifying student. If the credit more than wipes out your tax liability for the year, you’ll get a refund check from the IRS for up to $1,000 for each qualifying student.

Married couples filing jointly qualify for the full credit with a modified adjusted gross income of $160,000 or less, and single filers qualify with an income of $80,000 or less. The credit phases out completely at $180,000 for married couples and $90,000 for single filers.

Lifetime Learning. With this credit, you can claim 20% of your out-of-pocket costs for tuition, fees and books, up to $10,000, for a total of $2,000. Unlike the American Opportunity and Hope credits, the credit is not limited to undergraduate educational expenses, nor does the credit apply only to students attending at least half-time. You can claim the credit for yourself, your spouse or your dependent up to $2,000 per family each year.

You qualify for the benefit if your modified adjusted gross income is no higher than $120,000 for married couples filing jointly or $60,000 for single filers. Couples get the full credit at $100,000; singles at $50,000.

Dependency rules. If you earn too much an education credit and your student has some income of his or her own, you can elect to forgo the dependency exemption and let your student file his or her own tax return and claim the credit. This rule even applies if your income is so high that you lose the right to claim part of the personal exemptions for each of your family members.

Tuition deduction. If your income is too high to qualify for the American Opportunity or Lifetime Learning credit, you may qualify for a tax deduction of up to $4,000 for tuition and qualified expenses. Married couples filing jointly with an adjusted gross income of $160,000 or less qualify for the deduction, as do single filers with a modified adjusted gross income of $80,000 or less. You can take the deduction for yourself, your spouse or your dependent even if you don’t itemize. Although this deduction was scheduled to expire in 2009, proposed legislation would extend it.

Tapping tax-free college savings. You can take tax-free distributions for qualified education expenses from your child's 529 college savings plan or Coverdell Education Savings Account, formerly known as an education IRA. You can use tax-free withdrawals from Coverdell ESAs and 529 college savings plans in the same year as the Hope or Lifetime Learning credits as long as you don't use them for the same expenses. (See Everything You Need to Know About 529 Plans)

Tax-free savings bond interest. Interest earned on EE or I savings bonds issued after 1989 is tax free if the bond is used for college tuition and fee. As of 2010, the tax break starts to phase out at a modified adjusted gross income of $105,100 for married taxpayers filing jointly and at $70,100 for single filers. The break disappears completely when adjusted gross income is $135,100 for couples filing jointly and $85,100 for single filers. The tax-free provision cannot be combined with other educational tax breaks.

Return to: Tax Planning for All Life's Events

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