Tax Benefits

There are two education tax credits to help you offset the costs of higher education tuition by reducing the amount of your income tax. Tax credits are subtracted directly from the tax a family or student owes, while tax deductions are subtracted from taxable income. The two are the Hope Credit and the Lifetime Learning Tax Credit.

Hope Credit

To receive the Hope Credit, a family or student must file a federal tax return and owe taxes. Families and students that do not pay taxes cannot receive the Hope Credit. If a family or student owes less in taxes than the amount of the Hope Credit, the family or student can receive a credit equal only to the amount of taxes owed. The Hope Credit is the sum of 100% of the first $1,200 of qualified education expenses for the eligible student, and 50% of the next $1,200 of qualified education expenses paid for that student. The maximum is $1,800 ($3,600 for students in Midwestern disaster areas). The amount of the Hope Credit is gradually reduced (phased out) for those with modified adjusted gross incomes (MAGI) between $48,000 and $58,000 ($96,000 and $116,000 for joint returns). Hope credit may be claimed for the same student's expenses for no more than 2 years. An eligible student is one who is enrolled at last half time in a post secondary educational institution in which he is pursuing an undergraduate degree.

The Lifetime Learning Tax Credit

Like the Hope Credit, to receive the Lifetime Learning Tax Credit, a family or student must file a federal tax return and owe taxes because the amount of the credit is subtracted from the taxes owed. Individuals who do not pay taxes are not eligible for the Lifetime Learning Tax Credit. A family may claim a tax credit of up to $2,000 per tax year for the taxpayer, taxpayer’s spouse, or any eligible dependents for an unlimited number of tax years. The amount of the credit is 20% of the first $10,000 of qualified educational expenses paid for all eligible students. Unlike the Hope Credit which is only available for two years, the Lifetime Learning Tax Credit is available for all years of postsecondary education and for courses taken to acquire or improve job skills. The actual amount of the credit depends on a family’s income, the amount of qualified tuition and fees paid, and the amount of certain scholarships and allowances subtracted from tuition. This credit is family-based (up to $2,000 per tax return), unlike the Hope credit which is based on the number of eligible dependents in a family.

To receive the Hope Credit or the Lifetime Learning Tax Credit, the taxpayer must report the amount of qualified tuition and fees paid, as well as the amount of certain scholarships, grants, and untaxed income used to pay tuition and fees and complete IRS Form 8863.

Generally, a tax credit is more financially beneficial than a tax deduction. However, you should know about the Tuition and Fees Deduction. You may be able to deduct qualified education expenses paid for you, your spouse, or your dependent. The Tuition and Fees Deduction can reduce the amount of your income subject to tax by up to $4,000; it is taken as an adjustment to income. This means you can claim the deduction even if you do not itemize deductions on Schedule A of Form 1040. This deduction may be beneficial to you if you cannot take either the Hope or Lifetime Learning Credit because your income is too high. The amount of qualified education expenses that can be deducted is $4,000 for taxpayers with a modified adjusted gross income (MAGI) of $65,000 or less ($130,000 or less for married couples filing jointly. The maximum Tuition and Fees Deduction is $2,000 for taxpayers with a MAGI greater than $65,000 ($130,000 for married couples filing jointly), but not greater than $80,000 ($160,000 for married couples filing jointly). Taxpayers with a MAGI greater than $80,000 ($160,000 for married couples filing jointly) are not eligible for this deduction. The Tuition and Fees Deduction cannot be used in conjunction with the Hope Credit or the Lifetime Learning Credit. Please note that this tax benefit usually has a lesser impact on lowering your taxes than the Hope or the Lifetime Learning Credit.

Employer Provided  Educational Assistance

Employers may provide tax free tuition benefits up to $5,250 per year for study leading to a degree. Tax free educational assistance benefits include payments for tuition, fees and similar expenses, books, supplies and equipment. The payments may be for undergraduate or graduate level courses and the courses do not have to be work-related.

Student Loan Interest Deduction

Student Loan Interest Deduction allows you to deduct, for federal tax purposes, all student loan interest paid in any tax year. Federal and private educational loans are eligible, but not family or employer loans. The deduction may be taken in any year in which student loan interest is paid. You can reduce your income subject to tax by up to $2,500. The Student Loan Interest Deduction is available if the student's MAGI is less than $70.000 (or $145,000 if married and filing jointly). For those who wish to take advantage of this deduction, and qualify, IRS form 8917 must be completed and attached to form 1040 or 1040A. You cannot take the Student Loan Interest Deduction if your MAGI is $70,000 or more ($145,000 if filing a joint return).

For those who are planning their children's educations, there have been a number of improvements to the Section 529 plans and the Coverdell Education Savings Plan. Withdrawals from 529 plans are not taxable, the contribution limits on the Coverdell Accounts have increased to $2,000 and Coverdell proceeds may be used for primary and secondary educational expenses.

For further information, go to www.irs.gov and search for the latest issue of Publication 970.