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Education Tax Breaks
Under the
American Recovery and Reinvestment Act (ARRA), more parents
and students will qualify over the next two years for a tax
credit, the American Opportunity Credit, to pay for college
expenses.
The American
Opportunity Credit was not available on the 2008 returns
taxpayers are filing during 2009. This relatively new credit
modifies the existing Hope Credit for tax years 2009 and
2010, making the Hope Credit available to a broader range of
taxpayers, including many with higher incomes and those who
owe no tax. It also adds required course materials to the
list of qualifying expenses and allows the credit to be
claimed for four post-secondary education years instead of
two. Many of those eligible will qualify for the maximum
annual credit of $2,500 per student.
The full credit
is available to individuals whose modified adjusted gross
income is $80,000 or less, or $160,000 or less for married
couples filing a joint return. The credit is phased out for
taxpayers with incomes above these levels. These income
limits are higher than under the existing Hope and Lifetime
Learning Credits.
Hope Credit
The Hope credit
generally applies to 2008 and earlier tax years. It helps
parents and students pay for post-secondary education. The
Hope credit is a nonrefundable credit. This means that it
can reduce your tax to zero, but if the credit is more than
your tax the excess will not be refunded to you. The Hope
credit you are allowed may be limited by the amount of your
income and the amount of your tax.
The Hope credit
is for the payment of the first two years of tuition and
related expenses for an eligible student for whom the
taxpayer claims an exemption on the tax return. Normally,
you can claim tuition and required enrollment fees paid for
your own, as well as your dependents’ college education. The
Hope credit targets the first two years of post-secondary
education, and an eligible student must be enrolled at least
half time.
Generally, you
can claim the Hope credit if all three of the following
requirements are met:
-
You pay
qualified education expenses of higher education.
-
You pay the
education expenses for an eligible student.
-
The eligible
student is either yourself, your spouse or a dependent
for whom you claim an exemption on your tax return.
You cannot take
both an education credit and a deduction for tuition and
fees (see Deductions, below) for the same student in the
same year. In some cases, you may do better by claiming the
tuition and fees deduction instead of the Hope credit.
_________________
Education
credits are claimed on
Form 8863,
Education Credits (Hope and Lifetime Learning Credits). For
details on these and other education-related tax breaks, see
IRS Publication 970, Tax Benefits of Education.
Deductions
Tuition and Fees Deduction
You may be able
to deduct qualified education expenses paid during the year
for yourself, your spouse or your dependent. You cannot
claim this deduction if your filing status is married filing
separately or if another person can claim an exemption for
you as a dependent on his or her tax return. The qualified
expenses must be for higher education.
The tuition and fees deduction can
reduce the amount of your income subject to tax by up to
$4,000. This deduction, reported on
Form 8917,
Tuition and Fees Deduction, is taken as an adjustment to
income. This means you can claim this deduction even if you
do not itemize deductions on
Schedule A
(Form 1040). This deduction may be beneficial to you if, for
example, you cannot take the lifetime learning credit
because your income is too high.
You may be able
to take one of the education credits for your education
expenses instead of a tuition and fees deduction. You can
choose the one that will give you the lower tax.
Generally, you
can claim the tuition and fees deduction if all three of the
following requirements are met:
-
You pay
qualified education expenses of higher education.
-
You pay the
education expenses for an eligible student.
-
The eligible
student is yourself, your spouse, or your dependent for
whom you claim an exemption on your tax return.
You cannot claim
the tuition and fees deduction if any of the following
apply:
-
Your filing
status is married filing separately.
-
Another
person can claim an exemption for you as a dependent on
his or her tax return. You cannot take the deduction
even if the other person does not actually claim that
exemption.
-
Your
modified adjusted gross income (MAGI) is more than
$80,000 ($160,000 if filing a joint return).
-
You were a
nonresident alien for any part of the year and did not
elect to be treated as a resident alien for tax
purposes. More information on nonresident aliens can be
found in
Publication 519,
U.S. Tax Guide for Aliens.
-
You or
anyone else claims an education credit for expenses of
the student for whom the qualified education expenses
were paid.
Student-activity
fees and expenses for course-related books, supplies and
equipment are included in qualified education expenses only
if the fees and expenses must be paid to the institution as
a condition of enrollment or attendance.
Student Loan Interest
Deduction
Generally,
personal interest you pay, other than certain mortgage
interest, is not deductible on your tax return. However, if
your modified adjusted gross income (MAGI) is less than
$80,000 ($160,000 if filing a joint return) [these
are the 2016 MAGI limitations - they usually increase
annually], there is a
special deduction allowed for paying interest on a student
loan (also known as an education loan) used for higher
education. Student loan interest is interest you paid during
the year on a qualified student loan. It includes both
required and voluntary interest payments.
For most
taxpayers, MAGI is the adjusted gross income as figured on
their federal income tax return before subtracting any
deduction for student loan interest. This deduction can
reduce the amount of your income subject to tax by up to
$2,500.
The student loan interest deduction is taken as an
adjustment to income. This means you can claim this
deduction even if you do not itemize deductions on Form
1040's Schedule A.
Qualified Student Loan
This is a loan you took out solely to pay qualified
education expenses (defined later) that were:
-
For you,
your spouse, or a person who was your dependent when you
took out the loan.
-
Paid or
incurred within a reasonable period of time before or
after you took out the loan.
-
For
education provided during an academic period for an
eligible student.
Loans from the
following sources are not qualified student loans:
You can read the
current information on this topic on the IRS website by
clicking
here.
Qualified Education Expenses
For purposes of the student loan interest deduction, these
expenses are the total costs of attending an eligible
educational institution, including graduate school. They
include amounts paid for the following items:
The cost of room
and board qualifies only to the extent that it is not more
than the greater of:
-
The
allowance for room and board, as determined by the
eligible educational institution, that was included in
the cost of attendance (for federal financial aid
purposes) for a particular academic period and living
arrangement of the student, or
-
The actual
amount charged if the student is residing in housing
owned or operated by the eligible educational
institution.
Business Deduction for Work-Related Education
If you are an
employee and can itemize your deductions, you may be able to
claim a deduction for the expenses you pay for your
work-related education. Your deduction will be the amount by
which your qualifying work-related education expenses plus
other job and certain miscellaneous expenses is greater than
2% of your adjusted gross income. An itemized deduction may
reduce the amount of your income subject to tax.
If you are
self-employed, you deduct your expenses for qualifying
work-related education directly from your self-employment
income. This may reduce the amount of your income subject to
both income tax and self-employment tax.
Your
work-related education expenses may also qualify you for
other tax benefits, such as the tuition and fees deduction
and the Hope and lifetime learning credits. You may qualify
for these other benefits even if you do not meet the
requirements listed above.
To claim a
business deduction for work-related education, you must:
-
Be working.
-
Itemize your
deductions on Schedule A (Form 1040 or 1040NR) if you
are an employee.
-
File
Schedule C (Form 1040), Schedule C-EZ (Form 1040), or
Schedule F (Form 1040) if you are self-employed.
-
Have
expenses for education that meet the requirements
discussed under
Qualifying Work-Related Education, below.
Qualifying Work-Related Education
You can deduct the costs of
qualifying work-related education as business expenses. This
is education that meets at least one of the following two
tests:
-
The
education is required by your employer or the law to
keep your present salary, status or job. The required
education must serve a bona fide business purpose of
your employer.
-
The
education maintains or improves skills needed in your
present work.
However, even if
the education meets one or both of the above tests, it is
not qualifying work-related education if it:
You can deduct
the costs of qualifying work-related education as a business
expense even if the education could lead to a degree.
Education Required by Employer or by Law
Education you need to meet the minimum
educational requirements for your present trade or business
is not qualifying work-related education. Once you have met
the minimum educational requirements for your job, your
employer or the law may require you to get more education.
This additional education is qualifying work-related
education if all three of the following requirements are
met.
-
It is
required for you to keep your present salary, status or
job.
-
The
requirement serves a business purpose of your employer.
-
The
education is not part of a program that will qualify you
for a new trade or business.
When you get
more education than your employer or the law requires, the
additional education can be qualifying work-related
education only if it maintains or improves skills required
in your present work.
Education to Maintain or Improve Skills
If your education is not required
by your employer or the law, it can be qualifying
work-related education only if it maintains or improves
skills needed in your present work. This could include
refresher courses, courses on current developments and
academic or vocational courses.
Section 529Savings Plans
529 Plans Expanded
Tax-free college
savings plans and prepaid tuition programs can be used to
buy computer equipment and services for an eligible student
during 2009 and 2010. These 529 plans — qualified tuition
programs authorized under section 529 of the Internal
Revenue Code — have, in recent years, become a popular
way for parents and other family members to save for a
child’s college education. Though contributions to 529 plans
are not deductible, there is also no income limit for
contributors.
529 plan
distributions are tax-free as long as they are used to pay
qualified higher education expenses for a designated
beneficiary. Qualified expenses include tuition, required
fees, books, supplies, equipment and special needs services.
For someone who is at least a half-time student, room and
board also qualify.
For 2009 and 2010, the
ARRA change added to this list expenses for computer
technology and equipment or Internet access and related
services to be used by the student while enrolled at an
eligible educational institution. Software designed for
sports, games or hobbies does not qualify, unless it is
predominantly educational in nature. In general,
expenses for computer technology are not qualified expenses
for the American opportunity credit, Hope credit, lifetime
learning credit or tuition and fees deduction.
States sponsor
529 plans that allow taxpayers to either prepay or
contribute to an account for paying a student's qualified
higher education expenses. Similarly, colleges and groups of
colleges sponsor 529 plans that allow them to prepay a
student's qualified education expenses.
Coverdell Education
Savings Account
This account was
created as an incentive to help parents and students save
for education expenses. Unlike a 529 plan, a Coverdell ESA
can be used to pay a student’s eligible k-12 expenses, as
well as post-secondary expenses. On the other hand, income
limits apply to contributors, and the total contributions
for the beneficiary of this account cannot be more than
$2,000 in any year, no matter how many accounts have been
established. A beneficiary is someone who is under age 18 or
is a special needs beneficiary.
Contributions to
a Coverdell ESA are not deductible, but amounts deposited in
the account grow tax free until distributed. The beneficiary
will not owe tax on the distributions if they are less than
a beneficiary’s qualified education expenses at an eligible
institution. This benefit applies to qualified higher
education expenses as well as to qualified elementary and
secondary education expenses.
Here are some
things to remember about distributions from Coverdell
accounts:
-
Distributions are tax-free as long as they are used for
qualified education expenses, such as tuition and fees,
required books, supplies and equipment and qualified
expenses for room and board.
-
There is no
tax on distributions if they are for enrollment or
attendance at an eligible educational institution. This
includes any public, private or religious school that
provides elementary or secondary education as determined
under state law. Virtually all accredited public,
nonprofit and proprietary (privately owned
profit-making) post-secondary institutions are eligible.
-
Education
tax credits can be claimed in the same year the
beneficiary takes a tax-free distribution from a
Coverdell ESA, as long as the same expenses are not used
for both benefits.
-
If the
distribution exceeds qualified education expenses, a
portion will be taxable to the beneficiary and will
usually be subject to an additional 10% tax. Exceptions
to the additional 10% tax include the death or
disability of the beneficiary or if the beneficiary
receives a qualified scholarship.
For more
information, see
Tax Tip 2008-59,
Coverdell Education Savings Accounts.
Scholarships and
Fellowships
A
scholarship is generally an amount paid or allowed to, or
for the benefit of, a student at an educational institution
to aid in the pursuit of studies. The student may be either
an undergraduate or a graduate.
A
fellowship is generally an amount paid for the benefit of an
individual to aid in the pursuit of study or research.
Generally, whether the amount is tax free or taxable depends
on the expense paid with the amount and whether you are a
degree candidate.
A scholarship or
fellowship is tax free only if you meet the following
conditions:
Qualified Education Expenses
For purposes of
tax-free scholarships and fellowships, these are expenses
for:
-
Tuition and
fees required to enroll at or attend an eligible
educational institution.
-
Course-related expenses, such as fees, books, supplies,
and equipment that are required for the courses at the
eligible educational institution. These items must be
required of all students in your course of instruction.
However, in
order for these to be qualified education expenses, the
terms of the scholarship or fellowship cannot require that
it be used for other purposes, such as room and board, or
specify that it cannot be used for tuition or course-related
expenses.
Expenses that
Don’t Qualify
Qualified
education expenses do not include the cost of:
This is true
even if the fee must be paid to the institution as a
condition of enrollment or attendance. Scholarship or
fellowship amounts used to pay these costs are taxable.
For more
information, see IRS Publication 970.
Exclusions from
Income - Employer Assistance
You may exclude
certain educational assistance benefits from your income.
That means that you won’t have to pay any tax on them.
However, it also means that you can’t use any of the
tax-free education expenses as the basis for any other
deduction or credit, including the Hope credit and the
lifetime learning credit.
Employer-Provided
Educational Assistance
If you receive
educational assistance benefits from your employer under an
educational assistance program, you can exclude up to $5,250
of those benefits each year. This means your employer should
not include the benefits with your wages, tips, and other
compensation shown in box 1 of your Form W-2.
Educational Assistance Program
To qualify as an
educational assistance program, the plan must be written and
must meet certain other requirements. Your employer can tell
you whether there is a qualified program where you work.
Educational
Assistance Benefits
Tax-free
educational assistance benefits include payments for
tuition, fees and similar expenses, books, supplies, and
equipment. The payments may be for either undergraduate- or
graduate-level courses. The payments do not have to be for
work-related courses. Educational assistance benefits do not
include payments for the following items.
-
Meals,
lodging, or transportation.
-
Tools or
supplies (other than textbooks) that you can keep after
completing the course of instruction.
-
Courses
involving sports, games, or hobbies unless they:
-
Have a
reasonable relationship to the business of your
employer, or
-
Are
required as part of a degree program.
Benefits over $5,250
If your employer
pays more than $5,250 for educational benefits for you
during the year, you must generally pay tax on the amount
over $5,250. Your employer should include in your wages
(Form W-2, box 1) the amount that you must include in
income.
Working
Condition Fringe Benefit
However, if the
benefits over $5,250 also qualify as a working condition
fringe benefit, your employer does not have to include them
in your wages. A working condition fringe benefit is a
benefit which, had you paid for it, you could deduct as an
employee business expense. For more information on working
condition fringe benefits, see Working Condition Benefits
in chapter 2 of Publication 15-B, Employer's Tax Guide to
Fringe Benefits.
Questions and
Answers
If you still
have questions about the American Opportunity Credit, these
questions and answers
might help. |
