It's not always easy to determine which education tax credits and deductions you qualify for, and you might not know about all the tax breaks available. In fact, you probably have more options for saving on college costs than you think.
There are tax breaks for people saving for college, current students, and graduates who are paying off student loans.
Taking advantage of these education tax credits and other education tax breaks may help you keep more of your money.
Education Tax Break: 529 Plans
While investment income is generally taxable, income from investments in a 529 college savings plan is not. That means you won't need to pay federal taxes on the income you earn from your 529 plan (as long as you use it for qualified education expenses).
Some states also allow you to deduct your 529 plan contributions from your taxable income. That means you may not need to pay state income tax on the money you use to fund your 529 plan.
The rules for 529 savings plans don't always limit qualifying education expenses to college tuition or books. Parents and guardians may be able to use the savings to pay for other types of education. For example:
- You may use up to $10,000 for private K-12 education
- You may use your 529 savings plan to pay for trade school.
- You may change the beneficiary of the 529 savings plan if needed (transfer the plan to another individual).
What if my child doesn't go to college? Starting in 2024, up to $35,000 (lifetime limit) can, under a provision in the SECURE 2.0 Act, be rolled over from a 529 plan to a Roth IRA. So, your child or grandchild might be able to eventually benefit from your 529 contributions, even if they don't use the funds for education. However, there are rules governing these 529-to-Roth rollovers, one of which is that you had to have to 529 plan for at least 15 years. There are also specific plan beneficiary requirements.
Overall, rules and benefits for 529 plans vary by state and based the 529 savings plan you choose, so it is always important to do your research to see which plan best aligns with your family’s needs.
Education Tax Break: Coverdell Education Savings Accounts (ESAs)
Another way to save for college is through a Coverdell Education Savings Account (ESA). Like 529 plans, money deposited in a Coverdell ESA grows tax free, and there's no tax on distributions used for qualified college expenses. Additionally, you may choose your own investments with a Coverdell savings account. However, unlike 529 plans, the tax code places limits on who can contribute to a Coverdell ESA.
- Single people can contribute to a Coverdell ESA only if they have a modified adjusted gross income (MAGI) of $110,000 or less.
- Married couples filing a joint return can't have a modified AGI of more than $220,000.
(Modified AGI is equal to your federal AGI, plus any foreign earned income exclusion and/or housing exclusion, foreign housing deduction, and excluded income from Puerto Rico or American Samoa.)
There are other limits for Coverdell Education Savings Accounts.
- There maximum contribution limit for 2023 is $2,000 per child.
- You can only contribute to a Coverdell ESA until your child is 18 (unless your child has special needs).
- Amounts still remaining in a Coverdell ESA must be distributed within 30 days after the beneficiary's 30th birthday (unless the beneficiary has special needs).
Education Tax Credit: American Opportunity Tax Credit
The American Opportunity tax credit (AOTC) is an education tax credit available to people who are currently enrolled in college courses. The credit is partially refundable, meaning it is possible to receive part of the total credit as a tax refund.
- Eligible taxpayers (student, parent or spouse) can claim the credit for 100% of the first $2,000 spent on qualified education expenses (such as tuition, fees and textbooks).
- Eligible taxpayer can claim 25% of the next $2,000.
- The total credit is worth up to $2,500 for each qualifying student.
- If the credit amount exceeds the tax you owe for the year, you'll get a refund for 40% of the remaining amount, up to $1,000, for each qualifying student.
Not every student can claim the credit. If any of the following apply, you are ineligible to claim the AOTC.
- You are not in your first four years of college.
- You are not enrolled in college courses at least half-time for at least one academic period in the tax year.
- You are not pursuing a college degree or other qualified education credential.
- You have had a felony drug conviction.
- You are claimed as a dependent on another tax return.
- You have already claimed the AOTC (or the former Hope credit) for four tax years.
(Note: If the IRS audits your return and determines you claimed the credit when you were not eligible, you could be banned from claiming the credit for up to 10 years. Additionally, the IRS could impose a penalty for fraud.)
You can only claim qualified expenses for the AOTC. These include tuition and certain related expenses required for enrollment or attendance at the student's college (for example, necessary fees, books, supplies, and equipment).
What expenses do not qualify? Amounts paid for insurance, medical expenses (including student health fees), room and board, transportation, and living or family expenses do not qualify.
The amount of the credit you can claim depends on your adjusted gross income (AGI). If you can't claim the full credit, you may be able to claim part of it.
- Joint filers qualify for the full credit if their modified AGI is $160,000 or less
- Single filers get the full amount with a modified AGI of $80,000 or less
- The credit is gradually reduced to zero for married couples with a modified AGI between $160,000 and $180,000
- The credit is gradually reduced to zero for single taxpayers with a modified AGI between $80,000 and $90,000
There are a number of rules that prevent duplicate tax benefits. You can't deduct education expenses you use to calculate the AOTC anywhere else on your tax return. For example, if you deduct textbook expenses as a business expense, the IRS says you can't use those book expenses to calculate the AOTC.
Lifetime Learning Tax Credit
Another tax credit for people currently enrolled in college is the Lifetime Learning Credit (LLC). This credit is worth up to $2,000 per tax return. Unlike the American Opportunity tax credit, eligible graduate students can claim the credit. And students don't need to attend at least half-time to claim the credit, either.
This education credit can be claimed for an unlimited number of years, too. However, the Lifetime Learning credit is not refundable. This means it can reduce your tax bill to zero, but you won't receive any portion of the credit as a tax refund.
Income guidelines for the Lifetime Learning Credit are the same as those for the American Opportunity Tax Credit (AOTC).
- If you're married and filing a joint return, you can claim the full credit if you're modified AGI is $160,000 or less.
- Single filers with a modified AGI of $80,000 or less can claim the full credit.
- The credit is gradually reduced to zero for joint filers with a modified AGI between $160,000 and $180,000.
- For single taxpayers, the credit is gradually reduced to zero when the modified AGI is between $80,000 and $90,000.
Like with the AOTC, education tuition and fees required for enrollment qualify as education expenses. But more people may qualify for the Lifetime Learning Credit since classes to improve job skills might qualify.
Just like with the AOTC, the IRS says you cannot claim expenses you use to calculate the Lifetime Learning credit anywhere else on your tax return.
Tax Breaks for Scholarships and Other Assistance
A scholarship, fellowship, or grant may be excluded from taxable income if you're pursuing a degree at an eligible educational institution. Education assistance is only tax-free if the funds are used to pay for qualified education expenses.
What are Qualified Education Expenses?
- Tuition or fees that are required for enrollment or attendance
- Books, supplies, equipment, or other expenses that are required by the learning instituion for a class.
To be considered tax-free, scholarships can't exceed your education expenses or be used to pay for expenses such as room and board or travel.
What about VA education benefits? Payments to veterans for education under any law administered by the Department of Veterans Affairs are tax-free. However, if you qualify for other education tax benefits in addition to military benefits, you may have to reduce the amount of education expenses that you claim.
Qualified Tuition Reduction: If your tuition is reduced because you or a relative works for a college, you might not have to pay tax on the discount.
For graduate courses, only students who perform teaching or research activities for the educational institution can receive tax-free tuition reductions.
If you receive a tuition reduction for undergraduate courses, it's tax-free only if you meet one of the following criteria.
- are an employee of the college
- are a former employee of the college who retired or left on disability
- are a widow(er) of someone who died while employed by the college or who retired or left on disability
- are the dependent child or spouse of someone described above
Employer-Provided Educational Assistance
While not an education tax credit, employer-provided education assistance can sometimes result in a tax break. Workers who receive educational assistance benefits from their employer can exclude up to $5,250 of those benefits from their taxable income each year.
Employee educational assistance benefits must be paid under a written educational assistance program.
However, payments for the following items are not considered tax-exempt as part of employee education assistance.
- Meals, lodging, or transportation
- Tools or supplies (other than textbooks) that you can keep
- Courses involving sports, games, or hobbies (unless they have a reasonable relationship to the employer's business or are required as part of a degree program)
Employees generally have to pay tax on any educational assistance benefits over $5,250. However, benefits over the $5,250 limit are still tax-free if they qualify as a working condition fringe benefit. (a benefit that would be allowable as a business expense deduction if you had paid for it.)
If any portion of your employee education assistance is taxable, the amount will be listed in box 1 of your Form W2.
As a reminder, the IRS says you cannot claim expenses paid with tax-free employee assistance anywhere else on your tax return.
Education Tax Deduction for the Self-Employed
There are a number of self-employment tax deductions. For example, self-employed people generally can deduct the cost of work-related education as a business expense. This reduces the amount of income subject to both the federal income tax and self-employment tax. To qualify as a business deduction, the education must meet meet one of the following conditions.
- Be required to keep your present salary, status, or job
- Taken to maintain or improve skills needed in your present work
Even if your education meets the above qualifications, the IRS says you won't be able to claim education expenses as business deductions if any of the following apply.
- The education is needed to meet the minimum qualifications of your trade or business.
- The education is part of a program that would qualify you for a new trade.
Various types of expenses can qualify for education tax deductions if you are self-employed. These include (but are not limited to) the following.
- Books and supplies
- Lab fees
- Some transportation expenses (for example, transportation costs to get to and from classes)
What expenses aren't deductible? You cannot deduct the dollar value of vacation time or annual leave taken to attend classes.
If you used funds from a tax-free scholarship, grant, or employer-provided educational assistance to cover the cost of education expenses, you cannot those costs as a business expense.
Early Distributions from IRAs
Individual retirement accounts (IRAs) are meant to be used in retirement. You generally have to pay a 10% tax if you take money out of an IRA before you reach age 59½ .
However, it's possible to withdraw funds from an IRA to pay for qualified higher education expenses without having to pay the 10% tax penalty.
For the 10% penalty tax to be waived, early distributions should be taken in the same year that expenses are paid. Additionally, education expenses must be for one of the following people.
- Your spouse
- Your or your spouse's child, foster child, or adopted child
- Your or your spouse's grandchild
Many types of education expenses qualify to avoid the 10% penalty. According to the IRS, you can use early distributions to pay for the following qualified education expenses.
- Tuition and fees
- Books, supplies, and equipment required for enrollment or attendance
- For students attending on at least a half-time basis, room and board are qualified expenses, too
- For special needs students, expenses for any special services incurred in connection with the student's enrollment or attendance also qualify
Distributions that exceed the dollar amount of qualified education expenses are subject to the 10% penalty.
Note: You will still need to pay income tax on the amount withdrawn from IRAs, even if the distributions are used to pay for qualified education expenses.
Education Savings Bond Program
You might be able to cash in savings bonds without paying tax on the interest earned. To avoid paying tax on interest earnings, you can use the earnings to pay qualified education expenses for yourself, your spouse, or a dependent.
The savings bonds must be series EE bonds issued after 1989 or series I bonds. The bonds must also be issued either in your name (as the sole owner) or in the name of you and your spouse (as co-owners). Additionally, the owner must be at least 24 years old before the bond's issue date.
If you want to avoid paying federal income tax on interest from these savings bonds, you must use the earnings to pay for qualified education expenses.
Qualified Education Expenses
- Equipment and supplies (for example, a laptop)
Qualifying expenses must be paid to a school that is eligible to participate in federal student aid programs. The expenses should also be paid in the same year that savings bonds are redeemed.
You also need to have income that does not exceed the income threshold the IRS sets each year. You will claim your exclusion of interest from series EE and I savings bonds on Form 8815.
Education Tax Deduction for Student Loan Interest
In some cases, you can take an education tax deduction for the interest you paid on your student loans. You can take this deduction whether or not you itemize. (Most people take the standard deduction.)
You can only deduct up to $2,500 of student loan interest paid each year. However, how much you can deduct depends on your modified AGI. That $2,500 is gradually reduced to zero for single filers with a modified AGI between $70,000 and $85,000. For joint filers, the amount is reduced with a modified AGI between $145,000 and $175,000.
To deduct student loan interest, you must have taken out the loan solely to pay qualified education expenses for you, your spouse, or a person who was your dependent at the time you took out the loan.
These items are typically considered by the IRS to be qualified education expenses.
- Tuition and fees
- Room and board
- Books, supplies, and equipment
- Other necessary expenses (such as transportation to and from classes)
Married couples filing separate returns cannot claim the student loan interest deduction. You're also disqualified if someone else (such as a parent or guardian) claims you as a dependent on their tax return.
Education Tax Breaks for Student Loan Forgiveness
While federal student loan payments are set to resume in October, some graduates might have student loans forgiven through other programs. So, it's good to know whether your forgiven student loan amounts are taxable or tax-free.
If you have had $600 or more of your student loans forgiven, the forgiven amount could be considered taxable income. However, discharged loan amounts resulting from certain student loan forgiveness and repayment assistance programs are tax-free.
You may not need to pay income tax on amounts forgiven through the public service loan forgiveness or other assistance programs that are listed below.
- Teacher loan forgiveness
- Law School repayment assistance
- National Health Service Corps Loan Repayment Program (The 2023 application cycle is currently closed).
Katelyn has more than 6 years’ experience working in tax and finance. While she specializes in tax content, Katelyn has also written for digital publications on topics including insurance, retirement and financial planning and has had financial advice commissioned by national print publications. She believes that knowledge is the key to success and enjoys helping others reach their goals by providing content that educates and informs.
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