Whether you are paying off your own student loans, or paying the student loans of another person, higher education can be a very costly endeavor. Thankfully there are a number of tax benefits that exist to lower the amount of liability you will have from your student loans. These tax benefits range from credits to offset your tax liability, to college savings tax benefits.
American Opportunity Credit:
The first credit that exists is the American Opportunity Credit. This credit offsets your tax liability by 100% of the first $2,000 you spend on higher education expenses, and 25% of the next $2,000 of education expenses. This results in a max of $2,500 credit you can achieve through the American Opportunity Credit. Since it is a credit, it directly offsets your tax liability by the amount of the credit. If you do not have a tax liability at year end up to $1,000 of this credit can be refunded to you. These expenses must be qualified education expenses which are considered expenses that are necessary for being a student. These included tuition costs, required fees, books, school supplies, or any other fees that can be considered necessary. You should receive a form 1098 T detailing your tuition expenses. However, you are not limited to just the amount on a 1098-T as other expenses such as books and school supplies will not be included in this amount. Make sure you are keeping track of these expenses when you incur them.
To be fully eligible for this credit you must have under $80,000 income as a single filer or $160,000 if you are married filing jointly. Ther are phase out rules that exist with these income requirements and if you make over $90,000 if single or $180,000 married filing jointly you are not eligible for this credit. Additionally, the expenses must be paid when the person you are paying for is enrolled in school. If you are paying for yourself or paying education expenses on behalf of someone else, they must be enrolled as a student at some point during that tax year. They must also be someone that you can claim as a dependent on your tax return if you are claiming the credit on behalf of payments for someone else.
Lifetime Learning Credit:
The next credit that exists is the lifetime learning credit. You can receive up to a $2,000 credit per year under this credit. Qualified expenses for this credit are strictly payments for tuition and fees required for being a student. The credit is equal to 20% $10,000 of these expenses up to $2,000. Most institutions will send you a form 1098-T detailing the expenses you have paid for higher education.
It is similar to the lifetime learning credit in that you can only take it when you are enrolled in higher education for at least one period during the taxable year. It also has the same income requirements as the American Opportunity Credit. You are not eligible to take both the lifetime learning credit and American opportunity credit in the same year. The American Opportunity Credit is generally a more beneficial credit. However, the lifetime learning credit includes grad school expenses, where the American opportunity Credit can only be used for the first four years of higher education expenses.
Student Loan Interest Deduction:
A deduction that is allowed by taxpayers is the student loan interest deduction. This deduction allows you to deduct the student loan interest that you paid during the year up to $2,500. Additionally, you do not need to itemize your deductions to claim this credit, so anyone who meets the requirements can use student loan interest paid to lower their AGI for the tax year they made the payments in. If you made over $600 in student loan interest payments during a year you should receive a form 1098-E detailing exactly how much you have paid in student loan interest. If you did not receive a form or pay $600 in student loan interest, you can still include the amount of interest you paid to lower your AGI.
You can claim this deduction if you have under $75,000 AGI as a single filer and $150,000 if you are married filing jointly. Additional phase out rules apply at $90,000 for single and $180,000 for married filing jointly, and if you are above these AGI requirements you will not be eligible for this deduction. Since this is a deduction and not a credit the amount of this deduction lowers your overall taxable income instead of directly lowering your tax liability.
Coverdell savings accounts:
Planning for college expenses ahead of time can be a very worthwhile thing to do. A Coverdell education savings account can offer some extra tax benefits when you are planning for college expenses. Coverdell savings account allows you to input money into the account and have all earnings and withdrawals come out tax free. The person who the account is being opened for must be under 18 when it is created, and the funds must be used for any qualifying education expenses by the time they turn 30. If you end up taking withdrawals from the account for non-education expenses the withdrawals will be taxed.
Coverdell savings accounts let you contribute a maximum of $2,000 a year. You can contribute this maximum if your AGI is below $95,000 if filing single, and below $190,000 for Married filing jointly. There are phase out rules that exist up to $110,000 for single filing and $220,000 for married filing jointly. If you make above these income requirements, you are not eligible to contribute to a Coverdell Savings Account
529 plans:
A 529 is tax advantageous way of saving for college. The most common form of a 529 plan is the education savings plan. Like the Coverdell Savings Account, you invest money in the account and gains on this account can be taken out tax free when they are used for qualified education expenses. The money that you withdraw from 529 accounts also must be used towards qualified education expenses or you will be subject to taxes and penalties.
The rules for 529 plans are generally varied by the state that you open an account in. As a result, the maximum that you can contribute to a 529 plan is greatly varied by the state you have opened the account in. One benefit of the 529 plan is that there are no income limits to contributions, so people with high annual incomes can still contribute to these plans. Starting in 2024 If your children do not end up going to school you are allowed to put up to $35,000 from your 529 plan into a Roth IRA. If the plan has been active for 15 years or more. You can always withdraw funds from the 529 plan and not use them for education expenses. However, the money withdrawn will be subject to taxes on the gains as well as a penalty.
Written by Gabe Glahe, Staff Accountant