Guide to tax breaks for higher education

Anyone pursuing higher education is entitled to tax breaks. However, there is quite a number of them, and they can get kind of complicated. Moreso, there’s also the possibility of “locking” yourself out of some options by choosing other options. This is the prime reason why many prospective students choose to enlist the help of tax relief advocates before they settle on their tax breaks. That being said, it is not impossible to understand your options and choose the best option for your particular situation. But don’t worry, you’re not alone. This article is going to serve as your guide throughout all the tax breaks for higher education.

What is a higher education?

college library
A college is a prime example of higher education, but it is far from the only one.

To start with, we need to figure out what constitutes higher education. In a nutshell, higher education is:

  • Voluntary
  • Student-driven
  • Leads to a degree or a certificate

Furthermore, higher education represents studies beyond the high school level. It is also referred to as post-secondary education. The main facilitators of higher education are universities and colleges (including community colleges), but vocation-technical schools also count as higher education. In other words, if you are looking to cut your tax bills for higher education, you will need to enroll in one of these institutions. Now that you know what the term “higher education” means, let’s take a look at its associated tax breaks.

Tax breaks for higher education

There are four main “categories” of tax breaks for higher education:

  • Credits
  • Deductions
  • Savings plans
  • Income exclusions

Tax credits reduce the amount of income tax that you need to pay, while tax deductions reduce the amount of income that is subject to taxation. Both of them protect your income from taxes but in a different way. Savings plans allow the taxpayers to “set aside” money that will either grow tax-free or be distributed tax-free. In some cases, savings plans allow for both.

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Lastly, income exclusions allow the taxpayers to forgo paying income tax on associated benefits. However, using an income exclusion will disallow the use of any tax deductions or tax credits. While tax deductions and credits are preferable for most taxpayers, there are situations where pursuing income exclusions will present you with the greatest benefit.

Now, let’s take a look into each category but with a bit more detail.

Higher education tax credits

person holding a blank credit card
Tax credits are one of the most common tax breaks for higher education.

The great thing about higher education tax credits is the fact that they directly reduce the amount of tax that you owe. This means that the credit itself has the potential to reduce your tax lien to less than zero. If that happens, the IRS may even issue you a refund. The two credits that are available for higher education are:

  • American opportunity tax credit (AOTC)
  • Lifetime learning credit (LLC)

To get any of these two credits, you must first qualify for them. There are three rules that you must meet, and you need to meet them all:

  • Rule 1: You must be enrolled at an educational institution that qualifies for higher education credit. Your school will also provide you with a Form 1098-T, which will help you figure out the credit.
  • Rule 2: Someone needs to pay for the qualified education expenses for higher education. This can be you, your dependent, or a third party.  
  • Rule 3: The student receiving the credit must be either you, your dependent or your spouse, all of which need to be present on your tax return.

Lastly, you will need to fill out Form 8863 before you can take advantage of either tax credit.

Another thing to note is that you can’t benefit from both credits at the same time. Most of the time, students will be able to qualify for both credits in the same year and will have to make a choice between them.

American opportunity tax credit

U.S. flag and dollar bills, representing one of the tax breaks for higher education - American Opportunity Credit
American Opportunity Credit is one of the most commonly-used tax breaks for higher education.

The AOTC is a tax credit that covers the first four years of higher education. Eligible students can get a maximum of $2,500 per year in credit, and the credit can bring the tax lien to less than zero. If this happens, 40% of any remaining credit amount (up to $1,000) will be refunded to the taxpayer.

The way the AOTC works is by providing you with a 100% tax reduction on the first $2,000 spent on qualified higher education expenses, and a 25% tax reduction on the next $2,000 spent on the same, bringing the total to $2,500 of tax reduction.

There are income limits that might prevent you to claim full credit as well. If your MAGI (modified adjusted gross income) is $80,000 or less, you will be able to receive the full amount. Do note that this number is doubled in the case of married joint filers. If your MAGI is over $80,000 but below $90,000 (doubled for married joint filers), then you get the reduced credit amount. And if your MAGI is over $90,000 ($180,000 for married couples filing jointly), you cannot claim the credit at all. In this case, you might as well look into the best states for property taxes instead. While MAGI is different than AGI (adjusted gross income), for most people without any foreign sources of income, they are one and the same.

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If you happen to have foreign income sources and need to calculate your MAGI, you will need to add your foreign earned income exclusion, foreign housing exclusion, and your foreign housing deduction. Furthermore, if you are a bona fide resident of Puerto Rico or American Samoa, you will need to add your exclusion of income as well.

Lifetime learning credit

LLC is quite similar to AOTC but with one big difference. While the AOTC limits the students to the first four years of higher education, LLC does not have those limits. This means that you can be eligible for LLC even if you have finished your four years of studies and wish to enroll in future undergraduate, graduate, or professional degree courses. These courses even include acquiring new skills or improving existing ones. However, the limitations on LLC are somewhat harsher than those found in AOTC, as well.

First, LLC is “worth” up to $2,000 per annual tax return. Second, your MAGI needs to be between $59,000 and $69,000, or double that for married couples that are filing jointly. If your MAGI is more than $69,000 ($138,000 for joint filers), you cannot claim this credit. In the latter case, you might want to look into tax breaks for homeowners instead. Furthermore, the LLC is calculated a bit differently than AOTC. The amount of credit you receive is 20% off of the first $10,000 of qualified education expenses, up to $2,000. Also, LLC is not refundable, even if it brings your tax return lower than zero. Meaning no refunds.

Tax credits are the most popular tax breaks for higher education but they are not the only ones. Taxpayers also have access to tax deductions.

Tax breaks for higher education – Deductions

Aside from tax credits, you can also benefit from two more tax deductions:

  • Student loan interest tax deduction
  • Deduction for qualifying work-related higher education

Student loan interest tax deduction

blocks spelling "tax deductions"
Everyone loves tax deductions.

If you took out a loan to pay your qualified education expenses (and nothing else), you can deduct its interest from your tax return. However, your MAGI needs to be lower than $80,000 or $160,000 if you are filing jointly. Furthermore, you can benefit from this tax break for higher education even if you did not itemize your tax deductions to boost your tax refund amount. That being said, be very careful with student loans, as this tax deduction will “only” reduce your taxable income by up to $2,500.

Tax deductions for higher education that relate to work

You can benefit from these tax deductions if any of the following is true:

  • Your education is required either by your employer or by law
  • You need the education to maintain or improve the skills needed in your present work

But even if you meet one or both of the above requirements, you still may not qualify if this education is required to meet the minimum requirements of your current work, or is a part of a program that will have you qualify for a new line of work.

Tax breaks for higher education – Savings plans

Depending on the state you live in, you may also have access to dedicated higher education savings plans. These tax breaks for higher education include:

  • 529 plans
  • ESA (Coverdell Education Savings Account)

Both plans differ from state to state. They can be purchased either through the state directly, or through a financial advisor or a broker. Needless to say, you will want to make sure that you protect yourself from common IRS tax scams if you are going for the latter. While the savings plans do not provide great tax breaks for higher education, they are still tax-advantaged. Meaning that the money in the account grows either tax-free in the case of ESA, or tax-deferred in the case of 529 plans. While the contributions to the plans are limited and not tax-advantaged, withdrawals are absolutely tax-free. To make the most out of your savings plans, you might want to consult a professional.

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