You have probably heard of the interest deduction on student loans. But what you may not know is that this is just one of several tuition and student loan tax breaks that are enshrined in U.S. tax law.
There are also federal income tax breaks for saving for college through 529 College Savings Plans, Coverdell Education Savings, and the Education Savings Bond Program. And some states offer state income tax deductions or tax credits based on contributions to 529 plans.
Studying is getting more expensive every year. However, by taking advantage of as much tax breaks on tuition and student loans as possible, you can effectively lower the overall cost of your post-secondary education. Here are the credits and deductions that you should be aware of.
American opportunity tax credit
American Opportunity Tax Credit (AOTC) offers a partially refundable tax credit based on amounts spent on tuition, fees, and course materials. The course materials include the necessary textbooks, materials, and equipment.
The AOTC is valued up to $ 2,500 per student, which is 100% of the first $ 2,000 in eligible expenses and 25% of the second $ 2,000. The AOTC is partially refundable up to $ 1,000 (40%) and is not subject to Alternative Minimum Tax (AMT).
Taxpayers can claim the AOTC for up to four years of post-secondary education and a maximum of four tax years per student. And it can be claimed in addition to the current tax year for expenses in the first three months of the next tax year.
To qualify for the AOTC, the student must be at least halfway enrolled in a college or university that is eligible for Title IV government grants. And the student must pursue a college degree or certificate.
The AOTC rises from $ 80,000 to $ 90,000 for single taxpayers and $ 160,000 to $ 180,000 for married taxpayers filing a joint tax return. Taxpayers who file tax returns separately as a marriage are not eligible.
Tax credit for lifelong learning
Lifelong Learning Tax Credit (LLTC) offers a non-refundable tax credit of up to $ 2,000 per taxpayer based on 20% of the first $ 10,000 of tuition, fees, and required textbooks, supplies, and equipment. Note that the tax credit is per taxpayer, not per student.
The LLTC is more flexible than the AOTC in several ways. For one, it can be availed for an unlimited number of years. The student does not have to graduate either, so that the LLTC can be used for further education.
However, the loss of income for LLTC is slightly lower than for AOTC. It ends with a modified adjusted gross income (MAGI) of $ 59,000 to $ 69,000 for single parents and $ 118,000 to $ 138,000 for married applicants.
Scholarships with which tuition fees, fees and study-related materials (e.g. books, operating materials and equipment) are paid are tax-free if the student is aiming for a degree and the scholarship is not provided as payment for services.
However, amounts that are used to cover the cost of living, such as travel expenses and room and board, are taxable. The student must include the taxable portion of their scholarship on their federal income tax return.
Qualified scholarships are also exempt from FICA tax. There is also no income exit from income exclusion for qualifying scholarships, which can make this one of the most valuable perks on this list of tuition and student loan tax breaks.
Educational aid paid by the employer
Up to $ 5,250 of employer-paid education allowance can be excluded from taxpayer income. Eligible expenses include tuition, fees, books, supplies and equipment, and student loan repayment.
The student does not need to pursue a degree to avail of this service. Eligible courses can include bachelor’s, master’s and advanced training courses, as well as courses offered by the employer. The courses must be attended by the employee and not by the employee’s spouse or relative.
Although there is no income exit, the educational allowance paid by the employer must not discriminate in favor of high-paid workers. There is also a cap on the amount of assistance that can be given to owners or shareholders who own more than 5% of the company.
Interest deduction for student loans
The Student Loan Interest Deduction is an over-the-line income exclusion for up to $ 2,500 in interest paid on all government and most private student loans. It can also be asserted if the taxpayer does not list the deductions in his federal income tax return.
Student loan interest deduction ends at $ 70,000 to $ 85,000 for single taxpayers and $ 145,000 to $ 175,000 for married taxpayers filing a joint tax return. Taxpayers who file tax returns separately for marriage are not eligible. These income exits are valid for 2022 and are adjusted for inflation annually.
Tax exclusion for tuition fees
Under Section 2503 (e) of the 1986 Internal Revenue Code, tuition fees paid directly to an educational institution are exempt from gift tax. This tax break is only limited to teaching. Other college expenses such as fees, room and board, and transportation are not eligible.
This service is rarely required, as the annual gift tax exclusion is usually sufficient. The annual gift tax exclusion is $ 16,000 per donor and recipient in 2022. So, a couple could give up to $ 32,000 annually to each grandchild to cover college (or any other purpose) expenses. Contributions can be made up to five times the annual gift tax exclusion amount with a 529 plan through five year gift tax averaging.
There is no income exit due to gift tax exclusion from tuition fees. However, some colleges may treat such gifts as a resource that reduces the eligibility for on-demand grants on a dollar-for-dollar basis.
College savings plans
Contributions to college savings plans such as 529 plans, prepaid curricula, and Coverdell Education savings accounts are made in dollars after tax. The income is accumulated tax-deductible and is completely tax-free when used to pay for qualified university expenses.
Qualifying expenses for higher education include tuition, fees, books, supplies, equipment, and special needs expenses. Accommodation and meals are considered qualified expenses if the student is enrolled at least halfway through. Transportation is not a qualified expense.
Up to $ 10,000 student loan repayment is considered a qualifying issue on 529 plans. This is a lifetime limit for the borrower. The beneficiary and siblings of the beneficiary are each entitled to a repayment of the student loan of up to $ 10,000.
About two-thirds of states also offer a state income tax withholding or tax credit based on contributions to the state’s 529 plan. Seven of these states are making it available for contributions to each state’s 529 plan. All states except four grant the state income tax break even if the taxpayer pays a distribution the next day. The four states base their state income tax break on contributions minus distributions.
For 529 plans there are no annual contribution limits other than the gift tax exclusion. However, 529 plans allow five-year gift tax exclusions, also known as «superfunding,» which allow lump-sum contributions in excess of the annual gift tax exclusion to be treated as if they were made over a five-year period. Each state has its own contribution cap, which ranges from $ 235,000 to $ 542,000. There is no loss of income with 529 plans.
Check out our complete guide to the 529 plan and find your state to see what your state has to offer.
Coverdell Education savings accounts
Contributions to Coverdell Education Savings Accounts (ESAs) are capped at $ 2,000 per year from all sources up to the age of 18. There is a loss of income between $ 95,000 and $ 100,000 for a single parent and $ 190,000 to $ 220,000 for a jointly enrolled spouse. These exits are not adjusted for inflation.
Interest on the issuance of US EE Series savings bonds in 1990 and in subsequent years and on all US Series I savings bonds when the bond is used to pay tuition fees and fees is excluded from income. Income exclusion also applies to transfers to a 529 plan, prepaid curriculum, or Coverdell Education savings account.
There is an income jump from $ 85,800 to $ 100,800 (single) and $ 128,650 to $ 158,650 (co-married enrollment). Separate marriages are not permitted. These income exits are valid for 2022 and are adjusted for inflation annually.
Student loan forgiveness
The granting and discharge of student loans is tax-free until December 31, 2025. And there is a great chance this income exclusion will be extended or made permanent.
Even if this overarching benefit were removed, public service lending and a variety of other programs would remain tax-free. Other types of loan cancellations, such as B. Death and disability relief and the waiver that comes after the conclusion of an income-based repayment plan would, however, become taxable again.
It is important to understand that the IRS does not allow «double-dipping». Coordination restrictions prevent taxpayers from claiming two tax breaks for tuition fees and student loans based on the same qualifying expense. Every dollar of qualified expense can be used to claim just one tax break.
American Opportunity Tax Credit pays more per dollar of qualifying spend than Lifetime Learning Tax Credit, Qualifying Scholarships, and 529 Plan Payouts. So if a taxpayer is eligible for both the AOTC and the LLTC, they should choose the AOTC as it is more valuable.
Taxpayers should spend $ 4,000 in study and textbook expenses to qualify for the Maximum American Opportunity Tax Credit. For example, they could treat all or part of a grant as taxable in order to maximize their qualifying expenses for the AOTC.
For more information on tuition fee tax breaks and student loan tax breaks, see IRS Publication 970 – Education Tax Benefits. The 920 publication is typically updated in January or February each year.