Plan for Your Children’s Future with Federal Education Tax Credits

By Anna Kempton on August 8, 2017
Back to main Blog
Anna Kempton

plan for your children's educationIf you have children in college, you may already know the headache involved regarding tuition and college expenses. But if you qualify for federal education tax credits, you may see benefits on your individual tax return.

Here are some helpful hints when planning for your children’s future.

Don’t Double Dip with 529 Plans

If you have been making contributions to a 529 plan, these funds can be used towards qualifying college expenses. The federal government does not tax the earnings accumulated on a qualified 529 plan if they are appropriately used for qualifying education expenses. However, it is important to note that they will not allow you to double count the same expenses towards an education credit and a 529 plan distribution. 

For example, let’s assume that your only expense is tuition of $10,000 and that you pay all of the $10,000 with a distribution from a 529 plan, $2,000 of which is attributable to earnings on the investment. You are also eligible to claim the American Opportunities Tax Credit, in which $4,000 in qualifying education expenses need to be paid in order to get the full amount of the credit. Because you have taken a $10,000 distribution for the tuition and claimed a credit for $4,000 of expenses, you must pick up a portion of the income distributed from the 529 plan as income on your federal tax return. The amount to be picked up as income will be $800 [$2,000 in earnings X (4,000 non-qualified expenses / $10,000 total distribution)]. This is because $4,000 of the $10,000 distribution are not considered qualifying expenses for federal purposes, as they have already been allocated as such for the tax credit.

Three Opportunities for Federal Tax Breaks from Higher Ed Expenses

The federal government offers three opportunities for tax breaks related to higher education expenses:

  • The American Opportunities Tax Credit
  • The Lifetime Learning Credit
  • Tuition and fees deduction

The most advantageous of the three is the American Opportunities Tax Credit (AOTC). This is a credit up to $2,500 that can be taken per student, 40% of which is refundable. It is calculated by taking 100% of the first $2,000 in education expenses, followed by 25% of the next $2,000. While all three have phase-outs, the phase out for the AOTC is the highest at $180,000 married filing joint and $90,000 filing single. However, the qualifications for this credit are the strictest. This cannot be taken for more than 4 years for a student and the student must have been working towards a degree while attending school at least half time.

The Lifetime Learning Credit is a credit up to $2,000 calculated from 20% of education expenses. No portion of this credit is refundable, and the phase-out ends at $130,000 married filing joint and $65,000 filing single. This credit is allowed for any student who has taken one or more classes as part of a post-secondary degree program or to acquire or improve job skills.

Lastly, there is the tuition and fees deduction. This is a deduction up to $4,000 on the front of your Form 1040, with a phase-out at $160,000 and $80,000 for married filing joint and single filers, respectively. It is the least restrictive in that you only need to have expenses related to the enrollment in post-secondary classes in order to qualify for the deduction. This is great for those who are taking classes part-time but are phased-out of the Lifetime Learning Credit. It is also a good deduction for those students currently still in high school but taking Advanced Placement or college level courses.

“Qualified Education Expenses”

Another point to consider is the way each of these credits or deductions define “qualifying education expenses.” Unfortunately, the definition changes between each credit and deduction. Tuition expenses are always considered qualifying expenses and will always need to be reduced by scholarships and grants received. Related books, supplies, and equipment purchased can be included for purposes of the AOTC. However those items can only be considered for the lifetime learning credit and tuition and fees deduction if they are considered a condition of enrollment. Student activity fees may only be included as qualified education expenses if considered a condition of enrollment for any of the federal incentives. 529 plan distributions have the most lenient definition of qualifying education expenses, as they allow for all of the items listed above as well as distributions for room and board.

For help navigating the details and definitions to understand available federal education tax credits and deductions, contact us to learn more about our personal tax services

Stay up to date