Last Minute Tax Tips About Paying for College

on April 7, 2016

There are several college-related tax credits, exclusions from income and other education tax benefits that can be claimed on your federal income tax returns.

The most important ones are the American Opportunity Tax Credit (AOTC) and the Student Loan Interest Deduction.

  • The American Opportunity Tax Credit provides a partially-refundable tax credit of up to $2,500 per student, based on amounts spent on college tuition, required fees, course materials (textbooks, supplies and equipment) and computers (including peripherals, software and internet access). Up to 40 percent ($1,000) of the tax credit is refundable. The tax credit is based on 100 percent of the first $2,000 and 25 percent of the second $2,000. The student must be degree-seeking and enrolled at least half-time. The AOTC is limited to the first four years of postsecondary education and phases out with income of $80,000 to $90,000 (single filers) and $160,000 to $180,000 (married filing jointly). The income phase-outs do not change.
  • The Student Loan Interest Deduction is an above-the-line exclusion from income for up to $2,500 in interest paid on federal and private student loans. The Student Loan Interest Deduction may be claimed even if the taxpayer does not itemize. The Student Loan Interest Deduction phases out at $65,000 to $80,000 (single filers) and $130,000 to $160,000 (married filing jointly). The income phase-outs do not change.

Taxpayers who don’t qualify for the AOTC, such as graduate students, may qualify for the Lifetime Learning Tax Credit (LLTC). The Lifetime Learning Tax Credit is not as generous as the AOTC. It provides a tax credit of up to $2,000 per taxpayer based on 20 percent of the first $10,000 in tuition and fees for an unlimited number of years. The student does not need to be degree-seeking. The Lifetime Learning Tax Credit phases out in 2015 at $55,000 to $65,000 (single filers) and $110,000 to $130,000 (married filing jointly). The income phase-outs change annually.

There are several other exclusions from income, which are not subject to income phase-outs:

  • Employees can receive up to $5,250 in employer-paid tuition assistance each year, tax-free. The student does not need to be degree-seeking. Employees can receive more than $5,250 in employer-paid tuition assistance if the expenses are a working condition fringe benefit (i.e., required for the employee to keep his or her job, salary or status).
  • Student loan forgiveness is tax-free if the borrower must work for a period of time in a particular profession for a broad class of employers. For example, public service loan forgiveness is tax free.
  • Scholarships and fellowships amounts used to pay for tuition, fees and required course materials (textbooks, supplies and equipment) are tax-free if the student is degree-seeking and the money was not a fee for services. The full amount of scholarships and fellowships funding is also exempt from FICA taxes.
  • Earnings in 529 college savings plans, prepaid tuition plans and Coverdell Education Savings Accounts accumulate tax-free. Distributions for qualified higher education expenses are tax-free. Qualified higher education expenses include tuition, fees, course materials (textbooks, supplies and equipment), special needs services and, if enrolled at least half-time, room and board. Coverdell Education Savings Accounts are subject to additional restrictions, such as age limits and an annual $2,000 contribution limit per beneficiary.

The interest on Series EE U.S. Savings Bonds issued on or after January 1, 1990 and on all Series I U.S. Savings Bonds is tax free if used to pay for tuition and fees or rolled over into a 529 college savings plan, prepaid tuition plan or Coverdell Education Savings Account. The Education Savings Bond Program, however, is subject to income phase-outs, so it is best to roll the funds over into a 529 plan, which does not have any income phase-outs.

There are a few education tax benefits associated with retirement plan accounts. Taxpayers can take an early distribution from an IRA for qualified higher education expenses (tuition, fees, books, supplies, equipment, special needs services, and, if enrolled at least half-time, room and board) without incurring a 10 percent tax penalty. Such distributions are still subject to ordinary income taxes.

Hardship distributions from a 401(k) or 403(b) plan may be used to pay for college tuition, fees, room and board, but may still be subject to the 10 percent tax penalty. Taxpayers can borrow up to half of the vested balance of a 401(k), 403(b) or government retirement plan (but not an IRA) with a 5-year repayment term to pay for college costs. Of course, one may also take a tax-free return of contributions from a Roth IRA. Note that distributions from retirement plans may count as income on financial aid application forms even if tax-free.

For additional information about education tax benefits, see IRS Publication 970 (Tax Benefits for Education). Students should also read IRS Publication 17 (Your Income Tax) for an introduction to federal income tax.

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