Article By: Jeff Skolnick, CPA, M.S. Taxation

There are a number of items available in the tax code to assist taxpayers paying for qualified education expenses. These include tax credits, deductions and even a way to eliminate penalties on IRA distributions before age 59 ½.

I will start with the two different credits available for higher education tuition and fee expenses.  They are the American Opportunity Credit and the Lifetime Learning Credit. You are only able to use one of these credits per student in any tax year.

American Opportunity Credit

The American Opportunity Credit is available for any student within his/her first four years of post secondary education. The maximum credit allowed is $2,500. In addition, 40% of the credit is a refundable credit. This means it would be allowed even if income tax was reduced to zero. An example of this would be where a taxpayer has an income tax liability before any credits of $1,500. If the taxpayer had 1 child eligible for the maximum credit of $2,500, then the first 60% or $1,500 would offset the income tax, bringing it down to zero. The refundable portion of $1,000 would be allowed as a refund. 

The $2,500 limit is calculated as 100% of the first $2,000 of tuition and required fees and 25% of the next $2,000 of such fees. Qualified fees include tuition, required student activity fees, books, supplies and equipment. Room and board do not qualify.

Eligible students must also be enrolled in a program that leads to a degree, must be taking at least 50% of the course load needed to be considered full–time and not have any felony conviction for possessing or distributing a controlled substance.

There are also income phaseouts for this credit. This credit begins to phase out for individuals with income between $80,000 and $90,000 ($160,000 to $180,000 for joint filers). Married taxpayers filing separately do not qualify for the American Opportunity Credit.

Lifetime Learning Credit

This is a nonrefundable credit. The credit is a 20% credit on the first $10,000 of qualified tuition and fees paid for the taxpayer, spouse or dependents.  The maximum credit is therefore $2,000. This credit is per taxpayer, not per student. There is no degree or workload requirement. This credit is also not limited to the first four years of post secondary education.

There are also income phaseouts for the lifetime learning credit. This credit begins to phase out for individuals with income between $57,000 and $67,000 ($114,000 to $134,000 for joint filers). Married taxpayers filing separately do not qualify for the Lifetime Learning Credit.

In addition to the two credits discussed there are a few more programs available to assist taxpayers with the heavy burden of education expenses.

529 Plan

Technically called Qualified Tuition Programs, these plans are better known as 529 plans which refers to the Internal Revenue Code section in which they are defined. These plans allow individuals to prepay or contribute to an account for paying a student’s qualified education expenses. While there are a number of parts to these plans the basics are the following:

• Contributions to these plans are not tax deductible however if used for eligible education expenses none of the income earned will be taxable.
• Eligible education expenses include tuition and fees, books, supplies, equipment and room and board (although there are certain rules to be closely followed in this area).
• Beginning in 2018 it is now possible to use up to $10,000 per year per beneficiary for either elementary or secondary education expenses. Helpful to those with children in private schools.
• Coordinating with the annual gift tax exclusion, taxpayers may contribute up to $15,000 per beneficiary per year. This means parents can contribute $30,000 per year per beneficiary. In addition, the law allows a contribution equivalent to five years of the gift tax exclusion, or $75,000. You are then not eligible to give any gifts for the next four years. Technically, you can give gifts you would just have to file a gift tax return.
• The same expenses may not be used for the American Opportunity or Lifetime Learning Credits and for 529 distributions or Coverdell ESA Distributions (these will be explained next).

Coverdell Educaion Savings Account

For beneficiaries under 18 years of age, $2,000 may be contributed to an Education Savings Account (sometimes referred to as Education IRAs or ESAs). Married taxpayers filing jointly making the contribution will have this $2,000 figure phased out when their Modified adjusted Gross Income (MAGI) is between $190,000 and $220,000, for everyone else (including those married filing separately) the phaseout occurs between $95,000 and $110,000. Like the 529 plan contributions, ESA contributions are not deductible however if used for eligible education expenses none of the income earned will be taxable. Eligible expenses are basically the same as those allowed for 529 plans.

Again keep in mind the same education expenses cannot be used more than once. They can be used for the American Opportunity Credit, Lifetime Learning Credit, 529 plan or Coverdell ESA but only one type in a year. You may be able to utilize more than one benefit type in a year. In other words,  vthe American Opportunity Credit and 529 plan but you could not use the same expenses for both.

Other Benefits Available with regards to Education

Student Loan Interest

Taxpayers can deduct up to $2,500 of interest paid on qualified education loans. This deduction begins to phase out for individuals with income between $65,000 and $80,000 ($130,000 to $160,000 for joint filers). Married taxpayers filing separately do not qualify for the Student Loan Interest deduction. In addition, this deduction is allowed for taxpayers whether they itemize or not.

Exception to 10% Penalty on IRA Withdrawals Before Age 59 ½

Money withdrawn from your IRA (not 401K or other retirement plan, IRA only) and used for qualified education expenses of a taxpayer, spouse, child or grandchild will be exempt from the 10% penalty normally levied on early withdrawals. Eligible expenses are basically the same as those allowed for 529 or Coverdell ESA plans.

Tax Planning Tip

If you are in a position where you are unable to receive any benefit from the education deductions/credits previously discussed, then it may make sense to employ your child (if you are self-employed) and not claim them as a dependent or not claim them if they have other employment. The child would then be able to offset his/her income if they’ve exceeded $12,000.

Conclusion

This article only highlights education credits.  I would encourage taxpayers to contact a tax professional that has complete knowledge of these credits if they feel they may be eligible.

Check out my website at: https://jeffcpaworld.com/