Educational Tax Credits

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Michael Lodge    by Michael Lodge

This past week we had a tax client come in thinking she could deduct the tuition she paid sending her child to a private school.  She was shocked when she found out that she could not deduct the child’s tuition.  So now it is time to go over the education tax credits that are allowable and not allowable.

NOT ALLOWABLE:  Tuition paid to a private school for you child.  Sorry, not going to happen.  If you send your children to a private school, it can be very expensive.  The IRS hears you with to some extent, but it is very stingy with its available deductions for education-related expenses.  Depending on how much you earn, you may not be eligible for these tax perks at all.
 
KINDERGARTEN, ELEMENTARY AND HIGH SCHOOL:  General fule, tuition you pay for private or parochial schools is not deductible if your children are attending kindergarten through twelfth grade.  This is your choice that you have elected for your child, rather than spending them to a public school and the IRS give out no tax breaks.
SPECIAL NEEDS SCHOOLS:  An exception exists for special needs children who must attend a certain school for therapeutic or health care reasons.  This isn’t actually a tuition deduction.  It is a medical deduction, and your child’s physician or another licensed health care professional must prescribe your child’s attendance at the school.  To take advantage of this deduction, you must itemize deductions rather than use the standard deduction.  Depending on your circumstances, claiming these tuition costs might not actually be an advantage.  They’d have to exceed 7.5 percent of your adjusted gross income, and you can only deduct the difference.  For example, if your AGI is $175,000, your tuition costs would have to exceed $13,125, or 7.5 percent of that.  If tuition was $25,000, you could deduct $11,875, which is slightly less than a standard deduction for married couples filing jointly.  If you had no other itemized deduction you could claim, it might make more sense to take the standard deduction.
CHILD CARE:  If your children also attend before or after school daycare programs, this portion of your expense might cut your tax bill.  If you can distinguish between what amount of your overall bill is tuition and what constitutes child care, the latter might qualify you for the Child Care Tax Credit.  If you’re married, both you and your spouse would have to work and earn income, unless one of you is disabled.  Your children must be younger than 13, and they must enroll in the program to allow you and your spouse the freedom to work or look for a job.  Low-income families are eligible for credits, unfortunately, the value of the credits phase out at higher incomes.
COLLEGE TUITION:  College is more expensive than ever, but credits and deductions can help you cut thousands off your 2015 tax bill.

The American Opportunity Tax Credit

The familiar Hope Credit has been temporarily replaced by the new and improved American Opportunity Credit. For your 2015 taxes, the American Opportunity Credit:

  • Can be claimed in amounts up to $2,500 per student, calculated as 100% of the first $2,000 in college costs and 25% of the next $2,000.
  • May be used toward required course materials (books, supplies and equipment) as well as tuition and fees.
  • May be applied against four years of higher education (instead of just two years under the previous Hope Credit).

What’s more, the new tax credit is available to more taxpayers than the Hope Credit. The full credit may be claimed by people with adjusted gross income (AGI) of up to $80,000 for single taxpayers and $160,000 for married taxpayers filing jointly. The credit is gradually reduced at higher income levels. Lower-income taxpayers also benefit because up to 40% of the credit (or $1,000) is refundable, meaning that you can expect a check from the government if you owe no taxes

For your 2015 taxes, the American Opportunity Credit continues to replace the less-generous Hope Credit will return. The nonrefundable Hope Credit provides a maximum credit of $1,800 per student, but only for the first two years of college. It phases out for single taxpayers with AGI between $50,000 and $60,000 and for married taxpayers filing jointly with AGI between $100,000 and $120,000.

The Lifetime Learning Credit

The maximum annual credit is $2,000, calculated as 20% of the first $10,000 in qualifying educational expenses. But there is no limit on the number of years of higher education for which you can claim it. As a result, although the American Opportunity Credit yields a higher tax credit of up to $2,500 per student and is the best bet for most undergraduates, the Lifetime Learning Credit may be particularly helpful in reducing costs for graduate students or students who are taking post-secondary courses but not pursuing a degree.

Income limits for taking the Lifetime Learning Credit are the same as those for the Hope Credit, outlined above.

Married couples who file separate tax returns cannot claim any of these credits. In addition, you cannot claim the American Opportunity Credit and the Lifetime Learning Credit for the same student in the same year.

For 2015, most parents will come out ahead with the more generous American Opportunity Credit.

Additional tax breaks

You can save even more money on the cost of higher education thanks to a few other tax benefits:

  • Even if they don’t itemize their deductions, both parents and students can deduct up to $2,500 of interest on student loans through the end of the 2015 tax year. The deduction is available to single taxpayers with AGI under $75,000 and married taxpayers with AGI under $150,000. If you paid more than $600 in student loan interest you’ll receive Form 1098-E at tax time.
  • In 2015, when you redeem eligible Series EE and I bonds to pay qualified higher education expenses, the interest on those bonds is not taxable but this tax break begins to phase out if parents owning the bonds have AGI above $77,200 for single filers and $115,751 for married couples filing jointly. The interest exclusion from income is not available for taxpayers filing as married filing separately.
  • Interest on earnings in other plans you can use to save for college, including Coverdell Savings Accounts and 529 Education Savings Plans, is not taxable if you use the money to pay for higher education expenses. College expenses you pay from either of these plans aren’t eligible for the American Opportunity or Lifetime Learning credits. If the college expenses you pay in a particular year exceed the amount available from one of these plans, you are allowed to claim a credit for the excess amount.

Most education tax credits are taken by parents. But they can be claimed by students who pay their own college expenses, file their own tax returns and are not claimed as dependents on anyone else’s return.

We will update this for 2016 closer to the end of the year.