These Tax Breaks Can Ease the Pain of Paying for College

It's hard to find an upside to the high cost of attending college these days. But the good news is that by taking full advantage of tax breaks available to those paying tuition and other college-related expenses, you can put a decent-sized dent in the net amount you have to pay.

American Opportunity Tax Credit
For many taxpayers currently paying bills for college, the first place to look for relief is the American Opportunity Tax Credit, which is an expanded version of the Hope Tax Credit, first introduced as part of the 2009 federal stimulus package. The credit can offset up to $2,500 in tuition, fees, and course materials for a given tax year. If eligible you'll get a dollar-for-dollar credit for the first $2,000 in qualified expenses and a 25% credit on the next $2,000. There are restrictions, however. The credit is only available for those with modified adjusted gross incomes below $90,000 for single filers and below $180,000 for joint filers. Also, it may only be used for the first four years of post-secondary education and only applies to students carrying at least half of a full-time course load.

To illustrate the value of this credit, which was recently extended through 2017 as part of the fiscal cliff deal, consider that the average published in-state tuition and fees for a public four-year college during the current school year is $8,655, according to the College Board (this figure doesn't include room and board and other expenses). A taxpayer paying that amount and who qualifies for the full American Opportunity Tax Credit essentially gets a rebate of more than one fourth of tuition and fee expenses. For a taxpayer paying tuition and fees at a private nonprofit four-year school, where such costs average $29,056, the effect is less pronounced with a rebate of about 9%. In either case, a savings of $2,500 is a nice help; plus, the credit can be taken for each student in school. So a family with three children in college at once could conceivably save $7,500 by using this credit. The credit also is partially refundable, meaning that taxpayers who owe less in taxes than the credit is worth may still receive up to $1,000 of the credit as a refund.

Lifetime Learning Tax Credit
Households with part-time students or with full-time students who have exhausted their four-year eligibility for the American Opportunity Tax Credit have other options. The Lifetime Learning Credit can be used in these circumstances and even applies to those taking courses to enhance job-related skills. This nonrefundable tax credit is worth up to $2,000 per year (20% of qualified expenses up to $10,000) and may be used for an unlimited number of years. However, the $2,000 limit applies to the entire family regardless of the number of students in the home, and the income limit is lower than that of the American Opportunity Tax Credit. For the Lifetime Learning Credit, your modified adjusted gross income must be lower than $62,000 for single filers and $124,000 for joint filers. Tuition and other expenses required for enrollment (such as a student activity fee) are eligible for this credit. More information on the American Opportunity and Lifetime Learning tax credits is available on the Internal Revenue Service website.

Tuition and Fees Deduction
Another option for taxpayers who don't qualify for the aforementioned tax credits is to take the tuition and fees deduction, which helps offset the cost of tuition and expenses required for enrollment (but not room, board, and other expenses). Because it is a deduction rather than a credit, it effectively lowers the amount of income subject to tax rather than reducing your taxes dollar-for-dollar, making it less valuable. Eligibility and the size of the deduction are based on income. For single taxpayers making up to $65,000 and joint filers making up to $130,000, the maximum deduction per return is $4,000; for individuals making between $65,000 and $80,000 and joint filers making between $130,000 and $160,000 the maximum deduction per return is $2,000. So for a single taxpayer with a modified adjusted gross income of $64,000 in the 25% tax bracket, the $4,000 deduction translates into a savings of $1,000. Not as good as the tax credits, but still useful.

Taxpayers with multiple family members in school may use a combination of college-related tax credits and deductions on their returns but are limited to one credit or deduction per student per year. So choose carefully when filling out tax forms so you don't use the tuition and fees deduction when you could have taken the American Opportunity Tax Credit, for example. Also, you do have the option of using a tax credit or deduction for a student one year and using a different tax credit or deduction for the same student the following year.

One more college tax break worth mentioning is the student loan interest deduction. Up to $2,500 in interest paid on qualified college loans is deductible for single taxpayers with modified adjusted gross incomes of less than $75,000 or less than $155,000 for joint filers. The loan must have been taken out by the taxpayer and used to cover qualified education expenses for the taxpayer, the taxpayer's spouse, or a dependent.

Double-Dipping Not Allowed
You may be wondering where tax-advantaged college-savings accounts fit in with this picture. Plans such as 529s and Coverdell Education Savings Accounts allow individuals a way to save money in an investment account that enjoys tax-free growth and tax-free distributions for qualified college expenses. Contributions to an in-state 529 might even be deductible on your state income tax. But double-dipping when it comes to tax savings--that is, claiming a college tax credit for the same expenses you're paying with funds from a tax-advantaged college-savings account--is not allowed. For example, if you claim $4,000 worth of tuition payments toward the American Opportunity Tax Credit, you can't also have paid for that part of tuition using funds from a 529 or Coverdell. Given that the tax credit amounts to a dollar-for-dollar rebate for part of your educational costs, you're probably best off factoring the credit into how you plan to pay first and then covering additional expenses with the college-savings vehicle. For example, you might pay the first $4,000 in tuition from your current cash flow or a non-tax-advantaged savings account in order to qualify for the tax credit, and then pay additional expenses using funds from your 529 or Coverdell account.

Knowing the ins and outs of college-related tax breaks is one way to lighten your college-spending load. Used the right way, a mix of credits, deductions, and tax-advantaged savings accounts can help ease the strain on your family's finances.