QUICK LINKS: American Opportunity Tax Credit | Deduction for Qualified Tuition and Related Expenses | Lifetime Learning Credit | Section 529 Plans | Coverdell Education Savings Accounts | Educations Savings Bond Interest Exclusion | Employer-Provided Educational Assistance Exclusion | Job-Related Educational Expenses | Deduction for Interest of Education Loans | IRAs | Coordination
Tax breaks to help you pay educational expenses are some of the most commonly overlooked federal tax breaks. They shouldn’t be. These are very valuable tax breaks and we can help you maximize your tax savings.
Getting the most from the education tax incentives requires careful planning, particularly because of the interrelationship between many of the rules. Although the IRS provides guidance, some of the IRS’ explanations have actually complicated matters in some circumstances.
The Protect Americans from Tax Hikes (PATH) Act of 2015 makes permanent the modified and enhanced Hope Scholarship Credit known as the American Opportunity Tax Credit (AOTC). The PATH Act also extends the above-the-line deduction for qualified tuition and related expenses for two years to apply through 2016.
In addition to expanding these tax benefits, the PATH Act also includes provisions to prevent improper and fraudulent claims. Due to the refundable nature of a portion of the AOTC, additional criteria must be satisfied to be able to claim the credit. A due diligence requirement has been added and the penalties related to improper and fraudulent claims have been imposed.
An important compliance change included in other legislation requires an individual to possess a valid Form 1098-T, Tuition Statement, to claim the AOTC or the tuition and fees deduction.
American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) allows qualified taxpayers a credit of 100 percent of the first $2,000 of qualified tuition and related expenses and 25 percent of the next $2,000, for a total maximum credit of $2,500 per eligible student. Additionally, the AOTC applies to the first four years of a student’s post-secondary education. The AOTC was an enhanced, but temporary version of the permanent HOPE credit due to expire after 2017.
Up to 40 percent of the credit amount is refundable. The credit amount phases out ratable for taxpayers with a modified adjusted gross income (MAGI) between $80,000 and $90,000 (between $160,000 and $180,000, if filing jointly). MAGI is defined as AGI determined without regard to the exclusions for foreign income, foreign housing expenses, and U.S. possessions income.
To prevent retroactive credit claims, the identification requirements have been made stricter. No credit will be allowed if the taxpayer fails to include the qualifying individual’s name and tax identification number. Additionally, no credit will be allowed to students unless the tax identification number was issued on or before the due date for the filing of the return for the tax year.
As an additional deterrent to filing improper and fraudulent claims, a restriction on claiming the credit has been added for those taxpayers found to have made an improper or fraudulent claim on a previous year return. A claim for credit will be denied for 10 tax years after the tax year for which a final determination was made that the taxpayer’s claim for credit was due to fraud and two tax years after the tax year in which there was a final determination made that the taxpayer’s credit claim was due to a reckless and intentional disregard of the rules.
One final restriction has been added to be able to claim the AOTC. The taxpayer must include the employer identification number (EIN) for any institution to which qualified tuition and related expenses have been paid for him or herself. As a further measure to prevent improper and fraudulent claims, the amount listed on the informational returns will only be the amount actually paid for tuition and related expenses, not the aggregate amount billed.
Deduction for Qualified Tuition and Related Expenses
The PATH Act extends the above-the-line deduction for qualified tuition and related expenses through 2016. The higher education tuition deduction was created in 2001 and extended by subsequent laws through the end of 2014. The maximum amount of the tuition and fees deduction is $4,000 for an individual whose AGI for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose AGI does not exceed $80,000 ($160,000 in the case of a joint return). No deduction is allowed for an individual whose AGI exceeds these thresholds; a married individual filing a separate return; or an individual with respect to whom a dependency exemption may be claimed by another taxpayer.
Taxpayers cannot claim the higher education tuition deduction in the same tax year that they claim the AOTC or the Lifetime Learning credit. A taxpayer also cannot claim the education tuition deduction if anyone else claims the AOTC or the Lifetime Learning credit for the student in the same tax year.
The tuition and fees deduction is calculated on Form 8917 and reported on the taxpayer’s return. However, similar to the compliance rules for the AOTC, no deduction is allowed for the qualified education expenses of an eligible student unless the taxpayer includes the name and taxpayer identification number (TIN) of the student on his or her tax return.
There also older credits that are still available.
Lifetime Learning credit. The Lifetime Learning credit can be claimed for an unlimited number of tax years. The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. The Lifetime Learning credit is subject to phase-out rules based on adjusted gross income.
The Lifetime Learning credit may be applied to a non-degree program. For example, an individual who is enrolled in a non-degree program to improve job skills may be eligible for the credit. Moreover, the Lifetime Learning credit may be claimed even if the student is not enrolled at least half-time. An individual who is taking just one class at a community college, for example, may be eligible for the credit.
Section 529 plans. The Tax Code allows states and some educational institutions to offer “529” plans (known for the section of the Tax Code that governs them). They are also sometimes called qualified tuition programs (QTPs). They allow you to either prepay or contribute to an account for paying a student’s post-secondary education expenses. An eligible educational institution generally includes colleges, universities, vocational schools or other post-secondary educational institutions. In addition, distributions from state programs, even to the extent of earnings, are now entirely tax-free to the extent used for qualified higher education expenses.
Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for the beneficiary’s enrollment at an eligible educational institution, which includes most institutions that participate in federal student aid programs. Under the PATH Act, the purchase of computer equipment and technology with a distribution from a Code Sec. 529 plan is permanently considered a qualified expense. f the student is attending an institution at least half-time, room and board is treated as a qualified expense.
Coverdell education savings accounts. Coverdell education savings accounts (also sometimes called education IRAs) are similar to IRAs. You can save today for future educational expenses and not just higher educational expenses. Funds in a Coverdell ESA can also be used for K-12 and related expenses. The American Taxpayer Relief Act made permanent some temporary enhancements to Coverdell ESAs. The maximum annual Coverdell ESA contribution is $2,000 per beneficiary. Contributions are not deductible by the donor and are not included in the beneficiary’s income as long as they are used to pay for qualified education expenses.
Contributions generally must stop when the beneficiary turns age 18 except for individuals with special needs. Parents can maximize benefits, however, by transferring older siblings’ accounts for use by a younger brother, sister or first cousin, thereby maximizing the tax-free growth period. Excess contributions are subject to an excise tax.
The phase-out amounts of adjusted gross income allowed for a contributor to a Coverdell ESA are generous. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals.
Many individuals find Coverdell education savings accounts attractive because distributions can be used for room and board (if the designated beneficiary is enrolled at least half-time) as well as for qualified tuition and the costs of books and supplies required for enrollment. Beneficiaries who have special needs may also find these expenses qualify.
Education savings bond interest exclusion. When you use U.S. savings bonds to pay qualified higher education expenses, the interest may be excluded from income if your income is below a certain range. Qualified education expenses include the cost of tuition and fees at an eligible educational institution for the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent at an eligible educational institution. Colleges, universities and vocational schools that participate in federal student aid programs generally qualify for the incentive.
For bond interest to be excluded, the taxpayer must have attained the age of 24 before the issue date of the bonds. Qualified bonds must also be issued in the name of the taxpayer as sole owner or in the name of the taxpayer and the taxpayer’s spouse as co-owners. Married taxpayers must file a joint return to exclude bond interest.
Employer-provided educational assistance exclusion. When an employer pays an employee’s education expenses, the tax consequences depend on the reason for the education. Your employer may have a plan under which it pays for qualified education expenses for college or graduate studies. If it has such a plan, up to $5,250 of education benefits can excluded from the recipient’s gross income each year. Employer-provided educational assistance can include tuition, fees, books, supplies and equipment.
Job-related educational expenses. If you are taking a course because it is directly related to improving your job performance and your employer does not cover it, you may be able to deduct it as a miscellaneous itemized deduction if you itemized deductions. Under this deduction, tuition, course materials, and even the cost of transportation to and from class may be deductible. There are some restrictions, however: miscellaneous deductions are deductible only in excess of two percent of your adjusted gross income; and any degree program that qualifies you for a “new trade or business” cannot be deducted under this provision no matter how helpful it also may be to your present job.
Deduction for interest on education loans. Student loan interest of up to $2,500 a year is deductible whether or not you itemize your deductions. The deduction is completely phased when a taxpayer’s modified AGI exceeds certain thresholds. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person’s return cannot take this deduction. Qualified educational institutions for the student loan interest deduction are generally ones that participate in federal student aid programs.
IRAs. The Tax Code also allows individuals under age 59 1/2 to take distributions from an IRA for qualified higher education expenses without having to pay the 10 percent early withdrawal penalty. The qualified education expenses generally must be for the IRA holder, his or her spouse, or a child (including a foster child). Qualified education expenses include tuition, books and supplies. Room and board is also a qualified expense if the individual is at least a half-time student. An eligible education institution is generally one that participates in federal student aid programs.
Coordination. As you have read, there are many federal education tax incentives. All of the incentives must be coordinated; that is, you may not be able to take everyone. You generally cannot use education expenses to claim a double benefit. Many taxpayers make genuine and honest mistakes when trying to coordinate the education incentives without help from a tax professional. These mistakes are very costly. If you are considering claiming any of the education incentives, please contact our office.