College in the United States often comes with a hefty price tag. As per data from the National Center for Education Statistics, the 2019-20 academic year saw average tuition and fees amounting to $8,620 for public in-state universities, $19,034 for public out-of-state universities, and a substantial $29,371 for private nonprofit universities.
The cost of college has gone up significantly, leading to a huge increase in student debt, which has now reached $1.75 trillion. To make matters worse, the average student loan borrower ends up paying $1,898 in interest every year.
Several parents, guardians, and students are seeking relief from these financial burdens. Luckily, the government of the United States provides several tax incentives for college students, including tax credits, deductions, and tax-free savings accounts.
It’s important for taxpayers in the US to make the most of these tax breaks from the government. Whether you’re a parent or guardian funding your child’s college journey or a financially independent college student, these tax incentives could potentially save you thousands of dollars annually.
What Are College Tax Credits?
Among the various tax breaks for college students, tax credits stand out as highly beneficial. These credits directly offset the tax you owe, as opposed to solely reducing the taxable income amount.
The federal government provides two major education tax credits: the American Opportunity Tax Credit and the Lifetime Learning Credit. Taxpayers are eligible to claim only one of these tax credits designed for college students.
In order to qualify for either credit, you’ll need to complete Form 8863. Additionally, you should receive Form 1098-T from your educational institution, which will be mailed to the student and will detail the total amount spent on tuition and eligible expenses during the year.
Types of Tax Credit For College Students
The two types of tax credit for college students are explained below:
1. American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) offers a maximum annual credit of $2,500 per eligible student during their first four years of college. This credit can be used for expenses related to tuition, fees, and course materials. It’s important to note that expenses such as room and board, transportation, medical care, insurance, and nonrequired fees do not qualify.
The credit amount is calculated as 100% of the first $2,000 spent on qualified education expenses for each student, and an additional 25% of the next $2,000. Essentially, if your eligible education expenses total $4,000 or more, you can claim the maximum credit of $2,500.
What makes the AOTC particularly beneficial is its refundable nature, allowing you to receive up to 40% of the remaining credit amount, up to $1,000, even if it reduces your tax liability to zero.
To be eligible for the AOTC, students must be actively pursuing a postsecondary degree or a recognized education credential and be enrolled at least half time for one academic term during that tax year.
Keep in mind that the AOTC has income limits. To claim the full credit, your modified adjusted gross income must be $80,000 or less (or $160,000 or less for married couples filing jointly). If your income falls between $80,000 and $90,000 (or $180,000 if filing jointly), you can still receive a partial credit.
2. Lifetime Learning Credit
The Lifetime Learning Credit (LLC) resembles the AOTC but offers more flexibility. It applies to qualified tuition and related expenses for eligible students at qualifying schools.
Unlike the AOTC, the LLC has no restrictions on the number of years you can claim it, and there’s no requirement to pursue a degree or enroll at least half-time.
If you’re not an undergraduate, attending college part-time, or taking career development courses, these qualities make the LLC a more attractive option. However, it’s important to note that the student must be enrolled for at least one academic term starting in that tax year.
The LLC is slightly less beneficial for taxpayers compared to the AOTC because it’s nonrefundable. This means you can’t receive any of the credit as a refund, as you can with the AOTC. The LLC provides a credit amounting to 20% of the first $10,000 in qualified education expenses, with a maximum of $2,000 per tax return.
The income requirements for the LLC are somewhat limiting. You’re eligible to claim the credit only if your modified adjusted gross income falls below $69,000 (or $138,000 for joint filers). If your modified adjusted gross income falls within the range of $59,000 to $69,000 (or $118,000 to $138,000 for joint filers), the credit amount gradually decreases.
How College Tax Credit Works
Let’s say you’re a college student in the United States and you have $10,000 in qualified education expenses for the tax year. You’re eligible for the American Opportunity Tax Credit (AOTC), which can provide a maximum credit of $2,500.
Without the tax credit, you would owe taxes on your entire income, including the $10,000 spent on education expenses. However, with the AOTC:
- You can subtract the $2,500 tax credit directly from your tax liability.
- If your tax liability is less than $2,500, you may be eligible for a refund of up to $1,000, known as a refundable credit.
So, if your tax liability is $2,000, you can reduce it to zero using the AOTC. If your tax liability is $1,500, you can reduce it to zero and receive a $500 refund.
Who Qualifies for the College tax Credits?
Here’s a list of individuals who may qualify for college tax credits:
- Undergraduate Students: Typically, undergraduate students pursuing a degree or other recognized education credentials may qualify.
- Part-Time Students: Both full-time and part-time students may be eligible, depending on the specific credit.
- Parents and Guardians: Parents or guardians who are paying for their dependent children’s education expenses can often claim these credits.
- Eligible Educational Institutions: The credits usually apply to expenses incurred at eligible colleges, universities, and vocational schools.
- Modified Adjusted Gross Income (MAGI) within Income Limits: Eligibility can depend on the taxpayer’s MAGI, which should fall within specified income limits for each credit.
- Enrollment for at Least One Academic Term: Some credits require that the student be enrolled for at least one academic term during the tax year.
- No Felony Drug Convictions: Some tax credits may not be available to students with felony drug convictions.
- Qualified Education Expenses: Qualifying expenses typically include tuition, fees, and required course materials.
- Not Using Both Credits Simultaneously: Taxpayers can’t claim both the AOTC and LLC for the same student in the same tax year.
- U.S. Citizens or Eligible Noncitizens: Generally, only U.S. citizens, U.S. nationals, or eligible noncitizens can claim these credits.
Tax Deductions for College Students?
Tax deductions work by decreasing your taxable income, thus reducing the portion of your income that is subject to taxation.
Although not as beneficial as college tax credits, deductions for college students can still be quite beneficial, leading to a substantial reduction in your tax bill.
Furthermore, a reduced modified adjusted gross income may also enhance your eligibility for additional deductions and tax credits.
Student Loan Interest Deduction
The deduction for student loan interest allows taxpayers to subtract the interest amount they’re obliged or choose to pay, up to a maximum of $2,500, during the tax year. This deduction is for qualified student loans that were used to cover higher education expenses for yourself, your spouse, or a dependent.
It’s essential to note that loans obtained from private sources like family members, friends, or employer-sponsored plans are not eligible for this deduction. Additionally, the student must be enrolled at least half-time in an educational institution.
To qualify for this deduction, your modified adjusted gross income must fall below a specific threshold, which is adjusted annually. In the case of the 2020 tax year, your modified adjusted gross income needed to be less than $85,000 per year (or $170,000 for joint filers) to be eligible for the full deduction.
For individuals earning between $70,000 and $85,000 (or $140,000 and $170,000 for joint filers), deductions are gradually phased out.
Are There Any Other Tax Benefits for College?
Apart from college tax credits and deductions, there exist alternative methods to mitigate tax liabilities while financing higher education.
Education savings accounts, such as the Coverdell and the 529 plan, provide the advantage of tax-free growth on earnings and tax-free withdrawals when the funds are used for eligible educational costs. The individual who holds the account is exempt from paying taxes on the yearly increase in the initial investment.
Furthermore, funds withdrawn for educational purposes remain entirely tax-free, provided they are allocated towards covering educational costs.
Another avenue to explore is investing in an education savings bond program. Under this initiative, you may have the opportunity to exclude interest from your income when redeeming qualified savings bonds to finance higher education expenses.
Regarding Individual Retirement Account (IRA) funds, while the IRS typically imposes a 10% penalty for early withdrawals (before reaching the age of 59 and a half), this penalty can be waived if you utilize the funds for tuition and other qualified higher education expenses. However, it’s important to note that you may still be subject to income tax on the distributed amount.
Tax Credit For College Students Calculator
Here are some popular tax software options known for their user-friendliness and affordability, which are likely to be helpful for college students:
- TurboTax: TurboTax is widely used and offers a user-friendly interface. It provides step-by-step guidance and is known for handling complex tax situations, including education-related tax credits.
- H&R Block: The H&R Block offers a straightforward tax preparation process with various online and downloadable options. They also have in-person offices where you can get assistance.
- TaxAct: The TaxAct is known for its affordability and comprehensive tax solutions. They offer a free version for simple tax returns and a student discount.
- FreeTaxUSA: This online tax software provides free federal filing and low-cost state filing. It can handle education-related deductions and credits.
- IRS Free File: The IRS offers its own Free File software for eligible taxpayers. If your income is below a certain threshold, you can use this service for free.
- Credit Karma Tax: It offers free tax preparation services, including education-related credits and deductions.
- Online Tax Calculator Tools: In addition to software, you can use online tax calculators provided by reputable sources, such as the IRS website, to estimate your tax liability and credits.
Conclusion: Tax Credit For College Students
Tax credits can really help college students with money when they’re in school. Things like the American Opportunity Credit and Lifetime Learning Credit can cut down on the cost of tuition and school expenses.
There are other ways to save money on taxes when you pay off your student loans. You can use special savings accounts for education to avoid paying taxes on the money you earn.
Frequently Asked Questions (FAQs) and Answers on Tax Credit For College Students
Here are some frequently asked questions (FAQs) and their answers regarding tax credits for college students:
1. Who is eligible for college tax credits?
To be eligible, you generally need to be enrolled at an eligible educational institution, and there are income limitations. For specific eligibility details, consult the IRS guidelines.
2. What are the main college tax credits available?
The primary credits are the American Opportunity Credit and the Lifetime Learning Credit. They have different eligibility criteria and benefit amounts.
3. How do I claim tax credit for college students?
You usually claim these credits when you file your federal income tax return. Form 8863 is typically used for this purpose.
4. What expenses qualify for these credits?
Qualified expenses often include tuition, fees, and course materials. However, the specifics can vary, so refer to IRS guidelines for exact details.
5. Is there a limit to how many years I can claim these credits?
Yes, each credit has its own limit on the number of years you can claim it, so check the IRS guidelines for the credit you’re interested in.
6. Do state taxes offer college tax credits as well?
Some states offer their own education-related tax credits, so it’s worth checking with your state’s tax department for additional benefits.
7. What documentation do I need to claim these credits?
You’ll need records of your eligible expenses, as well as Form 1098-T from your educational institution. Keep these documents for your tax records.
8. How much is the American Opportunity Credit worth?
The AOC can provide a maximum annual credit of up to $2,500 per eligible student.
9. What’s the maximum credit for the Lifetime Learning Credit (LLC)?
The LLC offers a maximum annual credit of up to $2,000 per taxpayer, not per student.
10. Can I claim both the American Opportunity Credit and the Lifetime Learning Credit in the same tax year?
No, you can’t claim both credits for the same student in the same tax year. You must choose one or the other.
11. Do I need to report scholarship or grant income on my tax return?
Generally, scholarships or grants used for qualified education expenses are not taxable. However, there are exceptions to this law, so understand the rules.