1 Tax Breaks for Higher Education
tax breaks for higher education
Introduction
Expenses for higher education offer taxpayers many ways to reduce their income taxes. This can provide some relief from the high cost of college, graduate school, and other higher education courses. Careful planning before the expenses are incurred will assure that you receive the full benefit of these complicated tax breaks.
If you discover that you were eligible for a tax break but failed to claim it, you can file an amended tax return for up to three years from the date you filed the original return or two years after the date you paid the tax, whichever is later.
Legislation has added tax breaks and modified existing ones in recent years. The 2010 Tax Relief/Job Creation Act extended the more lenient rules for many tax breaks that were set to expire at the end of 2010. Those rules will now expire at the end of 2012, unless additional legislation is passed. This fact sheet explains the rules in effect for 2011 and 2012, and lists the rules that will go into effect on January 1, 2013 unless another extension is passed.
This fact sheet focuses on the tax aspects of the various credits, deductions, and other tax breaks available for higher education expenses. You will need to also weigh other advantages or disadvantages in choosing the tax breaks you will use.
How to Use This Fact Sheet
This fact sheet is intended to help you obtain the greatest tax benefits from expenses for higher education. The following descriptions of the sections in this fact sheet will help you find the information you need.
Highlights of Tax Breaks
Read this section for a brief overview of nine different tax breaks that are currently available.
Benefits, Requirements and Limitations of Specific Tax Breaks
Use this section to check all the details about the tax breaks for which you may be eligible. Is there an income limit on who can use the tax break? Do the classes have to be part of a degree program? Are books and other expenses covered?
Separate tables cover each of these topics:
- Tax Breaks: Basic Characteristics
- Whose Expenses Are Eligible?
What Expenses are Allowable?
Requirements for Student and Institution
- Type of Education Program Covered
- Additional Restrictions on Claiming Tax Breaks
Explanation of Terms
Many terms used in this fact sheet have very specific definitions. For other terms, the definition varies from one tax break to another. Check this section for definitions and explanations.
Claiming and Combining Tax Breaks
See how using one tax break affects eligibility for others so you can plan to maximize the benefits you get.
Tips on Ways to Make the Most of Tax Breaks
Use these suggestions to help you put this knowledge to work.
1 Tax Breaks for Higher Education
Highlights of Tax Breaks
Coverdell Education Savings Account(ESA, formerly known as Education IRA)
This trust or custodial account is created exclusively for the purpose of paying the beneficiary's qualified higher education expenses and, through 2012,expenses for grades K-12 at public or private schools. The annual contribution limit is $2000 per beneficiary($500 beginning in 2013). Contributions are not deductible. Contributions must be made by the beneficiary's 18th birthday. Special needs students are exempt from the age limit through 2012. Individuals and, through 2012, entities such as corporations and nonprofits can make contributions.
Distributions for qualified education expenses are tax-free. Qualified expenses do not include classes merely to improve or acquire skills. Any amounts withdrawn that are not used for qualified expenses or that are in excess of qualified expenses are taxed and subject to a 10% penalty tax. When the beneficiary reaches age 30, any money left will be taxed and assessed a 10% penalty tax. Avoid this penalty by rolling the money into an Education Savings Account for a younger family member or changing the beneficiary on the existing account.
American Opportunity Tax Credit (formerly Hope Scholarship Credit)
The American Opportunity credit can be used for all four years of collegeand can be used for books and course materials. The credit is a maximum of $2500: 100% of the first $2000 and 25% of the next $2000 of qualifying expenses. Forty percent of the credit is refundable (refundedeven if you owe no tax), unless student investment income is taxed at the parent’s rate.
In 2013, the American Opportunity credit is scheduled to revert to the Hope credit. The Hope credit can only be used for the first two years of post-secondary education. The credit of up to $1800 per student is calculated as 100% of the first $1200 of tuition and fees plus 50% of the next $1200 (2009; as indexed for inflation). The credit is used to reduce your income taxes, but it is not refundable if the credit reduces your taxes to less than zero.
To qualify for the American Opportunity or Hope credit, a student cannot have been convicted of a federal or state felony involving the possession or distribution of a controlled substance. Married taxpayers must file jointly to claim the credit. These credits cannot be used for classes to improve or acquire skills.
Lifetime Learning Credit
The Lifetime Learning Credit allows a wide range of students and educational programs to qualify, including half-time degree students and adults taking classes to acquire or improve job skills. This tax credit can be as much as $2000 per tax return, calculated as 20% of tuition and fees up to $10,000. The credit is used to reduce your income taxes, but it is not refundable if the credit reduces your taxes to less than zero. Married taxpayers must file jointly to claim the credit.
Student Loan Interest Deduction
Taxpayers can deduct interest on qualified higher education loans as an above-the-line deduction, meaning that even those who do not itemize will be able to take the deduction. Beginning in 2013, the deduction will be limited to interest paid on the first 60 payments.
Qualified higher education loans are debts incurred to pay qualified higher education expenses for the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer as of the time the debt was incurred. Loans for classes to improve or acquire skills do not qualify. The loan must be for expenses that were paid or incurred within a reasonable period of time before or after the debt is incurred. Married taxpayers must file jointly to claim the deduction.
Qualified Tuition Programs (529 Plans)
These programs, often referred to as Section 529 plans, meet allow taxpayers to save for or prepay tuition for a beneficiary and pay no tax on distributions used for qualified expenses. Nonqualified withdrawals are subject to regular income tax plus a 10% penalty (see IRS Publication 970 for exceptions). Tuition plans are for degree programs, not for classes to improve or acquire skills. Rollovers from one plan to another with the same beneficiary are limited to once in 12 months.
Two types of plans fall under this category. Prepaid tuition programsandsavings plans.
Prepaid tuition plans: Check the prepaid plan to see what flexibility you have if the student attends an out-of-state school or a private college. Both public and private educational institutions can offer prepaid tuition programs; distributions from those programs are tax-free.
Savings plans: Compare deferred savings plans from several states to find the best arrangement for you and your children. Evaluate the investment choices and the variety of schools that are covered. Some plans, especially the ones sold through brokers, charge high commissions and annual expenses.
Gift taxes may be owed if more than $13,000 ($26,000 for a married couple; 2011, indexed for inflation) is contributed per year for a single beneficiary. However, a contribution can be treated as if made over up to 5 years, allowing single contributions of up to $65,000 ($130,000 for a married couple; 2011, as indexed) without gift tax consequences.
Employee Assistance Plans
Employers may offer financial assistance for employee’s education of up to $5250 per year that is not reported as income, whether or not the classes are job-related. The exclusionapplies to both graduate and undergraduate classes.
Savings Bond Interest Deduction
Interest from US savings bonds may be excludable from income if used to pay for higher education expenses of family members. The exclusion phases out above certain income levels. The bond owner must have bought the bond after reaching age 24 and must be the sole owner or joint owner with spouse. The interest deduction applies in the year the bond is redeemed. Married taxpayers must file jointly. This deduction applies to both EE savings bonds purchased after 1989 and I-bonds that offer inflation-adjusted interest payments.
Withdrawals from IRAs
Traditional IRA. The early withdrawal penalty tax (10%) does not apply if the distribution is used to pay qualified higher education expensesof the taxpayer, spouse, or child or grandchild of the taxpayer or the taxpayer's spouse. However, income tax is still due.
Roth IRA. The early withdrawal penalty tax (10%) does not apply if the distribution is used to pay qualified higher education expenses. You will still owe income tax on the earnings in the account that were distributed. However, you may owe little or no tax since withdrawals from a Roth IRA are treated as being taken from contributions first, and there is no tax on withdrawals of contributions. Therefore, the only tax you might owe is on any earnings you withdraw after you have withdrawn all of your original contributions. You may not owe tax even on the earnings if you meet the criteria for regular retirement withdrawals.
Benefits, Requirements and Limitations of Specific Tax Breaks
The following tables provide specific information for each of the tax breaks introduced above. This section will help you determine whether you may be eligible for a particular tax break, what particular requirements you must meet, and exactly what expenses are covered.
1 Tax Breaks for Higher Education
TAX BREAKS: BASIC CHARACTERISTICSEducation Savings Account / American Opportunity(Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA Withdrawals
Income ranges over which eligibility is phased out / 2011 to 2012: modified AGI $95-110,000 (single),$190- $220,000 (joint)
Beginning in 2013: Joint income limits drop to $150-160,000 / 2011 and 2012: Modified AGI $80-90,000 (single), $160-180,000 (joint) (2011, as indexed)
Beginning in 2013, $50-60,000 (single), $100-120,000 (joint) (as indexed) / Modified AGI $51-61,000 (single), $102-122,000 (joint) (2011, as indexed) / 2011 and 2012: Modified AGI $60-75,000 (single), $120-150,000 (joint), (2009, as indexed)
Beginning in 2013: $40-55,000 (single), $60-75,000 (joint) (as indexed) / None / None / Modified AGI $71,100-$86,100 (single), $106,650-106,650 (joint) (2011, as indexed) / None
Annual dollar limit / Contribution per beneficiary: 2011 and 2012: $2000 by April 15 of following year.
Beginning in 2013: $500 by Dec. 31.
Distributions limited to amount of qualified expenses. / 2011 and 2012: $2500.
Beginning in 2013: $1800 per student (indexed for inflation) / $2000 per tax return / $2500 / Contribution limit depends on the plan. See Highlights and Tips regarding gift tax issues.
Distributions limited to amount of qualified expenses. / $5250 / Up to amount of qualified expenses / Up to amount of qualified expenses
WHOSE EXPENSES ARE ELIGIBLE?
Education Savings Account / American Opportunity (Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA Withdrawals
Taxpayer / Yes, if he/she is the beneficiary / Yes / Yes / Yes / Yes, if he/she is the beneficiary / Yes, if he/she is the employee / Yes / Yes
Taxpayers spouse / Yes, if he/she is the beneficiary / Yes / Yes / Yes / Yes, if he/she is the beneficiary / Yes, if he/she is the employee / Yes / Yes
Dependent / Yes, if he/she is the beneficiary / Yes / Yes / Yes, any dependent of taxpayer as of time debt was incurred / Yes, if he/she is the beneficiary / Yes, if he/she is the employee / Yes / Child, grandchild
Others / Can roll over to member of beneficiary’s family / No / No / No / Can change the beneficiary to another member of the current beneficiary’s family. / No / No / Child, grandchild
WHAT EXPENSES ARE ALLOWABLE?
Education Savings Account / American Opportunity (Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA WithdrawalsTuition and fees / Yes / Yes / Yes / Yes / Yes / Yes / Yes / Yes
Books / Yes, and supplies / Yes.
Beginning in 2013, No. / No / Yes / Yes / Yes[1] / No / Yes, and supplies
Room and board / Yes[2] / No / No / Yes / Yes, if half-time or more / No / No / Yes, if half-time or more
Computer technology, equipment, Internet service / No / 2010: only if the computer is needed forenrollment or attendance at the educational institution.
Beginning in 2011, No. / No / No / Beginning in 2011, computer purchase allowed only if required by the institution. / No / No / No
1 Tax Breaks for Higher Education
REQUIREMENTS FOR STUDENT AND INSTITUTIONEducation Savings Account / American Opportunity (Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA Withdrawals
Eligible student required? / No / Yes / Yes, except for expenses to acquire or improve job skills / Yes / No, except for room and board expenses / No / No / No
Eligible institution required? / Yes[3] / Yes3 / Yes3 / Yes3 / Yes3 / No / Yes3 / Yes3
% time required / NA except half-time for room and board / Half-time / Half-time[4] / Half-time / NA except half-time for room and board / NA / NA / NA except half-time for room and board
TYPE OF EDUCATION PROGRAM COVERED
Education Savings Account / American Opportunity (Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA Withdrawals
Undergrad-uate / Yes / Yes. For 2011 and 2012, first four years.
Beginning in 2013, first two years only. / Yes / Yes / Yes / Yes / Yes / Yes
Graduate / Yes / No / Yes / Yes / Yes / Yes / Yes / Yes
Recognized credential / Yes / Yes / Yes / Yes / Yes / Yes / Yes / Not specified
To acquire or improve job skills / No / No / Yes / No / No / Yes / Yes / Not specified
Elementary and Secondary school / 2011 and 2012: Yes[5]
Beginning in 2013: No / No / No / No / No / No / No / No
ADDITIONAL RESTRICTIONS ON CLAIMING TAX BREAKS
Education Savings Account / American Opportunity (Hope) Credit / Lifetime Learning Credit / Student Loan Interest Deduction / Qualified Tuition Programs / Employee Assistance Plans / Savings Bond Interest Deduction / IRA Withdrawals
# times can claim / No limit, but must use by age 30 / 2011 and 2012: four years per student,
Beginning in 2013, two years per student. / No limit / 2011 and 2012: No limit
Beginning in 2013: Limited to first 60 payments / No federal limit / No federal limit / No limit / No limit
Can you claim if you are the dependent of another? / Yes / No, but expenses paid by a dependent are treated as paid by the parent / No, but expenses paid by a dependent are treated as paid by the parent / No / No federal restriction / No federal restriction / Yes / Yes
Married couples must file jointly to claim? / Apparently, no / Yes / Yes / Yes / No / No / Yes / No
11 Tax Breaks for Higher Education
Explanation of Terms
Eligible institution
Definitions of eligible institutions vary for different tax breaks. Generally, they are post-secondary educational institutions eligible to participate in the federal student loan program, but may include others.
Eligible student
The qualifications required to be an eligible student vary by tax break. All require that the student be enrolled at an eligible educational institution. Some require that the student attend at least half-time. The Hope Credit requires that the student have no convictions for possession or distribution of a controlled substance. To check the definition of an eligible student for a particular tax break, see Tax Benefits for Education, IRS Publication 970 (
Half-time
For at least one academic period beginning during the tax year, the student must take at least one-half the normal full-time course load for the course of study being pursued.
Modified AGI
Several tax breaks are available only to those taxpayers whose modified adjusted gross income (AGI) is under certain limits. Adjustments to AGI vary with the individual tax break. The modified AGI may require adding foreign income and other amounts not normally taxed, including some other education tax breaks.
Dependent
A dependent is an individual whom you may claim on your income tax.
Qualified higher education expenses
Tuition and fees are included in qualified expenses. Some tax breaks may allow books and supplies to be included. Expenses for room and board are allowed by some tax breaks, usually for students who are enrolled on at least a half-time basis. To qualify as qualified higher education expenses, the educational institution may also be required to be "eligible.” (See “Eligible institution,” above.)
Claiming and Combining Tax Breaks
Each tax break has rules governing how and if it can be used in combination with other tax breaks. Before committing to using a particular tax break, compare to see if claiming it will limit your ability to claim another tax break that is more beneficial.
The following are general guidelines. Some of these proceduresmay change ifif legislation does not extend rules that are set to expire at the end of 2012. For more details, please refer to the appropriate IRS form or publication for the year in which you are claiming the tax break. A list is provided below.
If you are saving forhigher education expenses:
- You can contribute to both an Education Savings Account and a Qualified Tuition Program for the same student in the same year, at least until 2012. See Tips, below, for more information.
- Distributions from an Educational Savings Account are tax-free if contributed to a Qualified Tuition Program.
- Interest on qualifying savings bonds is tax-free if the proceeds are contributed to either an Education Savings Account or a Qualified Tuition Program.
If you are paying for higher education expenses: