What’s an education tax credit?

Key points

• Education tax credits include the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Tax Credit (LLTC).
• These credits can make college more affordable, but there are income restrictions.
• To claim the AOTC or the LLTC, you will need to get Form 1098-T, Tuition Statement, from your college.
• Other tax benefits include the student loan interest deduction and 529 college savings plans.

What if there was a way to get some help with your college tuition costs? By taking advantage of education tax credits, you can reduce your tax bill or even increase your refund amount depending on the amount of your tuition and the cost of course materials. If you’re eligible for credits like the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC), you could save a lot of money.

And education tax credits aren’t the only way you can save. There are tax deductions you can take, too. Here are the details on both, so you can take advantage of all the tax savings you can

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Education tax credits

Tax credits can reduce how much you owe in taxes—or even increase your tax refund. Some credits are refundable, meaning you may receive money back if you don’t owe taxes.

According to Monique McGrant, vice president at McGrant Tax and Bookkeeping, tax credits can be especially helpful for college students and their families.

“With higher education on the rise, education tax credits help offset the cost of attending school by reducing how much you owe on your tax return,” she says.

The following education tax credits can help reduce your tax burden.

American opportunity tax credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a credit for education expenses for a student’s first four years of college. It can reduce how much you owe in taxes by up to $2,500, depending on your income (or that of your parents). In some cases, the credit may be refundable. If the credit brings what you owe to the IRS to $0, you can have up to 40% of the remaining amount refunded to you, up to a maximum of $1,000.

Here’s how it works: AOTC gives you credit for 100% of the first $1,000 of qualified education expenses. After that, you get credit for 25% of the next $2,000 of qualified education expenses. Qualified expenses include tuition, fees and required course materials (like textbooks).

To be eligible for the AOTC, you need to meet the following criteria:

• You must be a college student or a parent paying education expenses for an eligible student—pursuing a degree or other recognized credential.
• If you’re claiming the credit as a student, you can’t be claimed as a dependent on another person’s tax return if you want a refund (but you can still get credit if you owe).
• You must be enrolled at least half-time for one academic period during the tax year.
• You cannot have a felony drug conviction.
• You must meet the AOTC income restrictions: For the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less if married filing jointly). A reduced credit is possible if your income is between $80,000 and $90,000, but you cannot claim the credit at all if your income is $90,000 or higher.

If you take more than four years to complete your degree or return to school, you are no longer eligible for the credit.

If you are a parent paying for education expenses for several children, you can claim the AOTC and get a credit for up to $2,500 per child per year.

To claim the AOTC, you need to get Form 1098-T, Tuition Statement, from the college. You’ll use that form to fill out Form 8863.

Tip: You can only claim the AOTC credit for qualifying expenses; to find out which expenses are eligible, consult IRS Publication 970.

Lifetime learning tax credit (LLTC)

If you aren’t eligible for AOTC, another education tax credit that may help is the LLTC.

“While you can claim both benefits on the same return, you cannot use them for the same student or the same qualified expenses,” says McGrant.

If you have two children in college, you can claim the AOTC based on one student’s qualified expenses and the LLTC based on the other student’s qualified expenses.

With the LLTC, you can claim a credit for 20% of up to $10,000 spent on qualified tuition and education expenses paid for eligible students enrolled in a qualifying college or educational institution. There is no limit on how many years you can claim the credit, making it especially useful for students in graduate school, continuing education programs or those who are completing certificate programs.

You can claim the credit for yourself or a dependent student. To qualify, you must be pursuing a degree, a certificate or a program to help you get a job or improve your job skills. You also must be enrolled for at least one academic period beginning in the tax year.

Tip: If you need help preparing your taxes or determining your eligibility for credits or deductions, consider meeting with a certified public account (CPA) or professional tax preparer. You can find one in the IRS directory of federal tax return preparers.

Some differences from the AOTC: The LLTC gives you a credit worth up to $2,000 per tax return—not per student and it’s not refundable (meaning if the LLTC reduces your tax bill to $0, you can’t receive the remainder as a refund).

As with the AOTC, you’ll need Form 1098-T from your college to claim the LLTC. You must also complete Form 8863. The same income limits as for the AOTC apply.

Education tax deductions

In contrast to tax credits, tax deductions reduce your income before you calculate what you owe in taxes. Depending on your situation, you may be able to take advantage of the following.

Student loan interest deduction

If you made payments toward a qualifying education loan, you can deduct $2,500 or the amount of interest you paid, whichever is less. To qualify for the deduction, you must be legally required to make payments toward a loan and you must have made payments during the specific tax year. The deduction is only available to taxpayers who aren’t filing their returns as married filing separately.

Qualified education loans include all federal student loans and most private student loans. Parent loans also qualify.

There are income limits: If your income is between $70,000 and $85,000 ($145,000 to $175,000 if you’re married and filing jointly), you can only qualify for a reduced deduction. If your income is $85,000 or more ($175,000 or more if married and filing jointly), the deduction is eliminated.

529 plans

If you are the parent of a child and you want to help them pay for college in the future, you can utilize a 529 plan. A 529 plan is a tax-advantaged savings plan you can use for future education costs.

There are two versions of the 529:

• Prepaid tuition plans: These plans allow you to purchase college credits for future use at today’s prices.
• Education savings plans: Education savings plans allow you to open an investment account to potentially grow your money to pay for qualified education expenses.

With a 529 plan, withdrawals used for qualifying expenses aren’t subject to income taxes. The account earnings aren’t subject to federal income taxes and, in some cases, state income taxes.

Tip: With a 529 plan, there are penalties for making non-education-related withdrawals, so be sure to evaluate your child’s goals before contributing money.

However, contributions to 529 plans aren’t tax-deductible at the federal level. There may be state income tax benefits and other incentives, but they vary by state. For example:

Illinois:

If you contribute to an Illinois Bright Start plan, you can deduct up to $10,000 per year ($20,000 if you’re married and file a joint return), and you’ll pay no state income tax on earnings or withdrawals.

New Mexico:

If you live in New Mexico, you can get a dollar-for-dollar deduction off your taxable income for your state tax return. New Mexico is one of just four states that doesn’t have a cap on possible deductions.

You can open a 529 plan in a different state, but it’s typically wise to consider your home state first since you may be eligible for special tax deductions or other incentives. To find a 529 plan and learn about its available tax benefits, visit CollegeSavings.org.