Tax Breaks for College Expenses

It’s no secret that college tuition is one of the most crushing financial burdens that American families face today. But the tax code provides several ways to ease some of the pain, depending on your income. For taxpayers who qualify, the American Opportunity Tax Credit, which Congress has extended through 2012, is probably the best choice.

The American Opportunity Credit is worth up to $2,500 per student per year during the first four years of college. It covers 100% of the first $2,000 of expenses, including tuition, fees and books, and 25% of the next $2,000.

You can claim the full credit if you are single and your income is $80,000 or less ($160,000 if you’re married filing jointly). You get a partial credit if you are single with income up to $90,000 ($180,000 for joint filers).Use Form 8863. A portion of the credit—40% of up to $1,000—is refundable, meaning you could get money back if the credit exceeds your tax bill.

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But if you’re paying for graduate school, the American Opportunity Credit won’t help you because it applies only to the first four years of college. However, you have other options. You can choose between claiming the Lifetime Learning credit Credit or a tuition tax deduction. (But you cannot claim the deduction and either of the credits in the same year for the same student).

The Lifetime Learning Credit covers 20% of the cost of any post- high school classes, up to a maximum $2,000 per tax return (not per student). For the full credit, your income can’t top $50,000 if you’re single ($100,000 if you’re married). A partial credit is available to those if you’re single with income up to $60,000 ($120,000 if married). Claim it on Form 8863. It is available for both 2010 and 2011.

If your income is too high to claim the Lifetime Learning Credit, consider claiming a tuition deduction of worth up to $2,000 or $4,000, depending on your income. It and is available whether or not you itemize. Unlike a tax credit, which reduces your tax bill dollar dollar-for for-dollar, a tax deduction merely reduces the amount of income that is taxed. For example, if you’re in the 25% bracket, a $2,000 deduction reduces your taxes by just $500 while a $2,000 credit reduces your taxes by the full $2,000.

You can claim the full $4,000 tuition deduction if you earn less than $65,000 ($130,000 if you’re married filing jointly). The deduction is limited to $2,000 if your income is between $65,000 and $80,000 ($130,000 and $160,000 if married filing jointly). Use Form 8917.

Paying back student loans

In addition to extending the higher higher-education tuition deduction through 2011, Congress also extended the student-loan interest deduction through 2011. It allows you to deduct up to $2,500 of interest paid on student loans, whether or not you itemize your deductions or choose the standard deduction.

The same law, the Tax Relief Act passed in December, also extends the educational assistance exclusion through 2012. It allows employees to exclude up to $5,250 in employer-provided educational assistance annually from income and employment taxes.