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All Contents © 2017The Kiplinger Washington Editors
By Kimberly Lankford, Contributing Editor
| November 30, 2015
Because federal tax law reaches deep into all aspects of our lives, it’s no surprise that the rules that affect us change as our lives change. This can present opportunities to save or create costly pitfalls to avoid. Being alert to the rolling changes that come at various life stages is the key to holding down your tax bill to the legal minimum.
Several tax breaks can ease the financial blow of college costs, whether you’re saving to send your kids to college, paying your own way, or adding on some graduate work. The following six tips can help you take full advantage of these tax breaks.
The American Opportunity Tax Credit is worth up to $2,500 per student for each of the first four years of college. The student must be enrolled at least half-time for one academic period during the year in a program leading to a degree, certificate or other recognized educational credential.
To qualify for the full credit, your adjusted gross income must be less than $80,000 if you are single or filing as head of household, or less than $160,000 if you are married filing jointly. The size of the credit starts to phase out as your income rises, disappearing entirely for singles and heads of household earning more than $90,000, and for couples filing jointly earning more than $180,000. Money spent on tuition, fees and books (but not room and board) counts toward the credit.
The credit is worth 100% of the first $2,000 you pay for eligible expenses, plus 25% of the next $2,000, totaling $2,500 for each of the four years. You can claim the credit by filing IRS Form 8863 with your Form 1040. Also see IRS Publication 970, Tax Benefits for Education for details.
The Lifetime Learning Credit is much more flexible than the American Opportunity Tax Credit. There is no limit to the number of years you can claim the credit, and the course must either be part of a postsecondary degree program or be taken to acquire or improve job skills. The course must be offered by an eligible educational institution, such as any college, university, vocational school or other postsecondary educational institution eligible to participate in the U.S. Department of Education student aid program.
The Lifetime Learning Credit is worth 20% of the first $10,000 of tuition, for a maximum of $2,000 per tax return. To qualify for the full credit for 2015, your income must have been less than $55,000 if single or filing as head of household, or less than $110,000 if you’re married filing jointly. The credit phases out entirely for singles and heads of household who earned more than $65,000 and for joint filers who earned more than $130,000.
You claim this credit by filing IRS Form 8863 with your 1040. For more information about the rules, see IRS Publication 970, Tax Benefits for Education.
SEE ALSO: 10 Worst College Majors for Your Career
Sponsored by 50 states and the District of Columbia, 529 plans let your earnings escape federal tax completely if the withdrawals are used for qualified college expenses, including tuition, fees, and room and board. Two-thirds of states give residents a tax deduction or another tax break for contributions. You are permitted to invest in other states’ 529 plans, although to get the tax break, you'll usually need to invest in your home state.
The appeal of 529 plans lies in their easy access as well as their tax benefits. The plans set no income limit and have a high limit on contributions. If your kid skips college, you can change the beneficiary to a sibling or other relative without losing the tax break. But use the money for non-college expenses and you’ll be on the hook for taxes and a penalty on earnings.
For more information about which 529 plan is best for you (your state of residence can make a big difference), see The Best 529 College-Savings Plans.
If you redeem I bonds and EE bonds issued after 1989 to pay college tuition, you may not have to pay taxes on the interest you earned. To qualify for the tax break, the bond owner must use the money to pay qualified education expenses (tuition and required fees, but not room and board) for himself, his spouse or a dependent. The bond owner must have been at least 24 years old when the bond was issued. That means the bonds must generally be owned by the parent, not the child. The child can be a beneficiary of the bonds but can’t be a co-owner.
For the interest to be tax-free, you must also meet certain income criteria. For 2015, the exclusion is phased out completely if your income is $145,750 or more for joint returns and $92,200 or more for single and head of household returns. For all of the interest to be tax-free, your modified adjusted gross income must be less than $115,750 for joint returns and less than $77,200 for single and head of household returns. For more information, see TreasuryDirect’s Using Savings Bonds for Education factsheet.
Up to $2,500 in student-loan interest can be tax-deductible for 2015 if your modified adjusted gross income is less than $65,000 if you’re single or less than $130,000 if married filing jointly. The deduction phases out as your income rises, disappearing completely if you earn more than $80,000 if single or more than $160,000 if filing a joint return.
You do not have to itemize your deductions to qualify, but you can’t be claimed as a dependent on your parents’ tax return. You may even be able to deduct the interest your parents paid on a loan for which you are liable. For more information, see IRS Publication 970, Tax Benefits for Education
Scholarships are tax-free up to the cost of tuition and course-related expenses, such as books and supplies. Money for anything else not required for enrollment, including housing and travel, is taxed as income. And any scholarship money received as payment for services, such as teaching or assisting in a lab, may be taxed.
SEE ALSO: 11 Top Sources of College Scholarships
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