Individuals and families who pay college tuition, fees, and other related expenses may be eligible for a tax break on their federal income tax. This section describes various programs and tax benefits that may make higher education more affordable for many families. This information is meant as a guide only. For more detailed information on all the tax benefits outlined below, consult your tax professional or refer to IRS Publication 970, Tax Benefits for Higher Education, available online at irs.gov or by calling the IRS at 1-800-829-1040. Copies of the publication may also be available in your local library, guidance office, or post office.
American Opportunity Tax Credit
The American opportunity tax credit (AOTC) is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.
The amount of the credit is 100 percent of the first $2,000 of qualified education expenses you paid for each eligible student and 25 percent of the next $2,000 of qualified education expenses you paid for that student. But, if the credit pays your tax down to zero, you can have 40 percent of the remaining amount of the credit (up to $1,000) refunded to you.
Lifetime Learning Credit
The Lifetime Learning Credit is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses--including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return.
Student Loan Interest Deduction
Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntarily pre-paid interest payments. You may deduct the lesser of $2,500 or the amount of interest you actually paid during the year. The deduction is gradually reduced and eventually eliminated by phaseout when your modified adjusted gross income (MAGI) amount reaches the annual limit for your filing status (more than $80,000 or $165,000 if filing a joint return).
Coverdell Education Savings Accounts
Coverdell Accounts are funds established exclusively for higher education expenses (including tuition and fees, books, supplies and some room and board expenses) for individual children under the age of 18. Contributions must be made “after taxes.” However, earnings accumulate tax free and no taxes are paid on withdrawals provided they are used for higher education expenses. The maximum contribution is $2,000 per year. (Families of military personnel killed in action may contribute 100 percent of survivor benefits.) The benefit is phased out for single filers with adjusted gross incomes greater than $110,000, and for joint filers with adjusted gross incomes greater than $220,000.
Qualified Tuition Programs and 529 Plans
A qualified tuition program (QTP) is one in which the contributor (a student’s parent, grandparent or other individual) prepays college tuition to an eligible educational institution or contributes to an account established for the purpose of paying qualified educational expenses. Earnings accrued on the QTP that are used to pay qualified educational expenses including tuition, fees, books, supplies, equipment, and room and board (student must attend at least half-time) are free from federal tax and in some cases from state taxes as well.
Contributions to a QTP cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary. There are no income restrictions for this program.
Student Loan Interest Deduction
You can take a tax deduction for the interest paid on student loans that you took out for yourself, your spouse, or your dependent. This benefit applies to all loans (not just federal student loans) used to pay for higher education expenses. The maximum deduction is $2,500 a year.
Using IRA Withdrawals for College Costs
You may withdraw from an IRA to pay higher education expenses for yourself, your spouse, your child, or your grandchild.
You will owe federal income tax on the amount withdrawn, but won't be subject to the early withdrawal penalty.