The education of
your children, or even of yourself and your spouse, can be a major investment.
Knowing if your college-age child is still a dependent, what scholarships are
taxable, and which tax credits are available can be confusing. You need to
consider your situation to determine which options are best for you. Tax
planning is essential to make the most of these benefits. You should determine
whether your adjusted gross income disqualifies you from using one of the
options or whether your education expenses qualify for the benefit you are
considering. The definition of qualified educational expenses often differs
between the different tax saving options. You should also consider issues other
than tax, for example, the student's eligibility for financial aid and who has
control over the money used for college. In certain circumstances, it might be
better to have the child pay the education expenses rather than the parent; in
other circumstances, it might be better to have the parent pay the education
expenses for the student.
Keep the following in mind when preparing your
- Scholarships and Grants
- Student Loan Interest Deduction
- Tuition and Fees Deduction
- Coverdell Education Savings Account
- Qualified Tuition Programs
- Higher Education Credits
- Education Savings Bond Program
Whether a student is claimed as a dependent on your tax
return may affect your eligibility, or the student's eligibility, for the
different tax benefits available for education expenses.
A student is
someone enrolled in school full-time for at least five months out of the
calendar year. A full-time student under age 24 who has a job may still be
claimed as a dependent on their parents' return. If your child must file a
return, they cannot claim their own exemption if they qualify as your
Students are allowed to take the standard deduction even if
they are not claiming their own exemption. The standard deduction amount of a
dependent may be lower than the standard deduction of a person who is not a
Scholarships and Grants
A candidate for a degree can
exclude from income amounts received for tuition, books, and fees. Amounts used
for room and board do not qualify for exclusion.
Amounts received by a
scholarship candidate for services such as teaching or research are taxable
income even if providing such services is a required condition for receiving
the scholarship or grant.
Scholarship prizes won in a contest are not
considered scholarships/fellowships if they are not designated to be used for
educational purposes only. These must be included in gross income.
Payments from the Department of Veterans Affairs are not considered
scholarships and are not included in income.
Scholarship and fellowship
payments for teaching, research, or other services paid by the National Health
Services Corps Scholarship Programs or by the Armed Forces Health Professions
Scholarship and Financial Assistance Program are not included in income.
Student Loan Interest Deduction
You may be able to deduct up to
$2,500 of interest you paid on a qualified student loan to attend an
accredited, higher educational institution. The loan must have been for you,
your spouse, or someone you claimed as your dependent when you took out the
loan. This deduction is an adjustment to income so you can claim it even if you
do not itemize deductions on Schedule A, Itemized Deductions. Your modified
adjusted gross income must be less than $75,000 ($150,000 if Married Filing
Jointly). If you are filing Married Filing Separately, you cannot take this
Tuition and Fees Deduction
You may be able to deduct
up to $4,000 for qualified tuition and fees paid for higher education even if
you do not itemize deductions. Qualified tuition and fees are amounts paid for
you, your spouse, or a person whom you claim as your dependent. The tuition and
fees must be required for enrollment or attendance at an eligible educational
institution. You may qualify for the maximum $4,000 tuition and fees deduction
if your modified adjusted gross income is $65,000 or less ($130,000 or less if
Married Filing Jointly) or a reduced tuition and fees deduction of up to $2,000
if your modified adjusted gross income is greater than $65,000 ($130,000 if
Married Filing Jointly) but not more than $80,000 ($160,000 if Married Filing
Jointly). If your modified adjusted gross income is greater than $80,000
($160,000 if Married Filing Jointly), you cannot take this deduction.
This deduction is not available:
- If the American Opportunity
Credit or Lifetime Learning Credit is claimed for the student
returns filed with a Married Filing Separately filing status
- To a
person who can be claimed as a dependent on another person's return, even if
the other person chooses not to claim the person as a dependent
Qualified expenses used to take the tuition and fees deduction must be
reduced by any tax-free benefits received, such as distribution of earnings
from a Qualified Tuition Program (QTP) or tax-free savings bond interest.
Qualified expenses must also be reduced by the full amount of a Coverdell
Education Savings Account (Coverdell ESA) distribution.
Charmaine's modified adjusted gross income is under $65,000. She incurred
qualified tuition expenses of $5,000 for her son, Anwar, who is a student
Charmaine claims as her dependent. Anwar received a $6,000 distribution as the
beneficiary of a QTP, of which $500 represents the tax-free earnings. He also
received a $1,000 distribution from a Coverdell ESA. Charmaine's allowable
tuition and fees deduction is $3,500 ($5,000 qualifying expenses less $500
tax-free earnings less $1,000 Coverdell ESA distribution).
Education Savings Account (ESA)
The Coverdell Education Savings Account
(Coverdell ESA) is a custodial or trust account for the sole purpose of paying
for the qualified education expenses of the designated beneficiary. The
designated beneficiary is considered the owner of the account, which may affect
the beneficiary's eligibility for financial aid. The designated beneficiary
assumes control of the account upon turning age 18.
In addition to higher
education expenses, qualified expenses include certain elementary (including
kindergarten) and secondary public, private, or religious school tuition and
expenses. Expenses include books, tutoring, computer equipment, software and
services, room and board, uniforms, extended-day program costs, and the
expenses of an individual with special needs that are necessary for that
person's enrollment or attendance at an eligible educational institution.
Anyone, including the beneficiary, can establish and contribute to this
account. However, if the beneficiary is under age 18, the parent or guardian of
the beneficiary must set up this account. You can make a contribution to a
Coverdell ESA if your modified adjusted gross income for the year is less than
$110,000 ($220,000 if Married Filing Jointly). If your modified adjusted gross
income is above the limit, it is possible for you to provide the beneficiary
with the money as a gift and have the beneficiary make the contribution on
their own behalf, as long as the beneficiary's modified adjusted gross income
is not over the limit. The maximum total of all contributions for any one
beneficiary cannot be more than $2,000 per tax year. No additional
contributions can be made to the account once the beneficiary turns age 18,
unless the beneficiary is an individual with special needs.
contributions are not tax deductible but earnings are tax free to the
beneficiary if they are used to pay for qualified education expenses. A 10%
penalty may apply to a distribution that is not applied to qualified education
expenses. Money remaining in the account after paying for a beneficiary's
qualified expenses can be rolled into another family member's Coverdell ESA
account tax free if certain conditions are met.
Contributions to a
Coverdell ESA are considered a gift from the contributor to the beneficiary and
are eligible for the annual gift tax exclusion.
A Qualified Tuition Program (QTP or Section 529 plan) is a
program that allows you to prepay a student's college tuition or contribute to
a higher education savings account for payment of qualified higher education
expenses. Qualified expenses include books, supplies, equipment, and room and
board if the student is attending at least half-time. Half-time attendance is
defined by the institution. Plans can be established by a state agency or by a
qualified educational institution. You are not restricted to investing in your
state's plan, but contributions to your own state's plan may qualify you for
certain additional tax benefits on your state tax return.
You may make
nondeductible contributions to a QTP for yourself or for any other beneficiary,
regardless of your relationship to the beneficiary. There are no age
restrictions and no income restrictions on the individuals contributing to the
Contributions are not tax deductible. The part of a distribution
representing the amount contributed to a QTP is not included in income.
Earnings distributed by a QTP are not included in income if the total
distribution is used to pay qualified education expenses. This exclusion from
income applies to distributions from QTPs established and maintained by private
colleges and universities. Previously, only distributions from programs
established by a state agency qualified for this exclusion. A 10% penalty may
apply to the taxable part of the distribution.
A QTP is not a custodial
account; therefore, the beneficiary is not considered the owner of the account.
The parent, as the account holder, is able to change the designated beneficiary
at will. For example, if the current beneficiary obtains a scholarship and no
longer needs the money, the account holder can assign a new beneficiary. Money
remaining in the account after paying for a beneficiary's qualified expenses
can be rolled into another family member's QTP account tax free if certain
conditions are met.
Contributions to a QTP are also considered a gift
from the contributor to the beneficiary and are eligible for the annual gift
You can contribute to both a QTP and a Coverdell education
savings account in the same year for the same beneficiary.
The following two tax credits are available to
taxpayers who pay higher education costs:
- The American Opportunity
Credit - Available through 2017
- The Lifetime Learning Credit
The American Opportunity Credit is a credit of up to $2,500 for the
qualified tuition and related expenses paid for each eligible student. The
credit is 100% of the first $2,000 of qualified expenses plus 25% of the next
$2,000 of qualified expenses paid per student. It can be claimed for the first
four years of postsecondary education for each student. The student must be
enrolled at least half time in a qualified program and must not have been
convicted of a felony drug offense. Eligible expenses include tuition, required
fees, and the cost of required books and software for courses.
You do not
qualify for the credit if your modified adjusted gross income is greater than
$90,000 or $180,000 if married filing jointly.
The American Opportunity
Credit is unique in the fact that it combines both a nonrefundable and a
refundable credit in one. The first 40% of the credit up to $1,000 is
refundable with the balance of the credit treated as a nonrefundable credit.
This unique feature allows you to receive the refundable portion of the credit
as a refund if you have no remaining taxes.
You may be able to claim a
Lifetime Learning Credit of up to $2,000 each year for the total qualified
tuition and related expenses paid during the tax year for all eligible students
who are enrolled in eligible educational institutions. This credit is 20% of
the first $10,000 of qualified expenses paid per tax return. Unlike the
American Opportunity Credit, the Lifetime Learning Credit is not based on the
student's workload and is not limited to the first two years of postsecondary
education. Expenses for graduate-level degree work are eligible. You do not
qualify for the credit if your income is greater than $62,000 ($124,000 if
Married Filing Jointly). The Lifetime Learning Credit is a nonrefundable
credit. This means that if your taxes are less than your credit, then you will
lose any remaining credit amount left after you reduce your taxes to zero.
Both of these credits are nonrefundable and may be reduced based on your
income. You may claim the American Opportunity Credit for any of the first four
years of a student's postsecondary education and claim the Lifetime Learning
Credit for that same student in later tax years. You can claim the American
Opportunity Credit for one child and the Lifetime Learning Credit for another
student in the same tax year. College students who pay expenses using a
Coverdell Education Savings Account (Coverdell ESA), a Qualified Tuition
Program (QTP), or education savings bond funds may also claim an education
credit if the expenses used for the credit are different expenses than those
paid with distributions from these funds.
You do not qualify for either
credit if your filing status is Married Filing Separately. In addition, you
cannot claim either the American Opportunity Credit or the Lifetime Learning
Credit for a student in the same year you are claiming the tuition and fees
deduction for that student.
You must claim the student as a dependent to
receive either education credit. If you do not claim the student as a
dependent, or if someone else is eligible to claim the student as a dependent
but elects not to, only the student may claim the credit. A student claimed as
a dependent on another person's tax return cannot claim the credit.
Claiming the American Opportunity Credit may be more beneficial than
claiming the Lifetime Learning Credit, if you are eligible for both. Also,
claiming one of the education credits is usually more beneficial than taking
the tuition and fees deduction because a credit offsets the tax liability
dollar for dollar. However, if you do not qualify for any of the education
credits (for example, because of modified adjusted gross income restrictions)
you may instead decide to take the tuition and fees deduction on your
For example, Brad's filing status is Single, and he has wages of
$31,000. After allowing for the standard deduction and personal exemption
amount, his tax is $2,756. He is a sophomore in college and paid $10,000 in
qualified tuition expenses during the year as part of a degree program. He has
no other income or deductions. Brad has the choice of taking the American
Opportunity Credit, the Lifetime Learning Credit, or the tuition and fees
deduction. He should choose whichever option gives him the biggest tax
If Brad takes the tuition and fees deduction, which allows a
maximum deduction of $4,000, he would save $600 in taxes ($4,000 x 15% tax
If Brad takes the Lifetime Learning Credit instead, he would save
$2,000 in taxes (the maximum credit amount) because his income is below the
limits. In this scenario, the credit gives you $1,400 more in savings than the
tuition and fees deduction would.
If Brad takes the American Opportunity
Credit instead, he would save $2,500 in taxes (the maximum credit allowed)
because his income is below the limits. In this scenario, the credit gives him
$1,900 more in savings than the deduction would.
The maximum allowable
American Opportunity Credit is $2,500 per student. The maximum allowable
Lifetime Learning Credit is $2,000 per tax return. In the preceding scenario,
if Brad's education expenses had been $7,000, the American Opportunity Credit
would save $1,100 more in taxes than the Lifetime Learning Credit. The American
Opportunity Credit would still be $2,500, but the Lifetime Learning Credit
would only be $1,400 ($7,000 expenses x 20% Lifetime Learning Credit rate).
If your income level disqualifies you from using the Lifetime Learning
Credit, you might still be able to take the American Opportunity Credit or the
tuition and fees deduction. In the preceding scenario, had Brad's income been
$63,000, he would not qualify for the Lifetime Learning Credit (the modified
adjusted gross income limit for credit is $62,000 for Single filers). He is
still eligible for the American Opportunity Credit of $2,500. He is also
eligible for the tuition and fees and deduction. If he chooses the tuition and
fees deduction, he could claim a $2,000 tuition and fees deduction and, if he
takes the standard deduction, realize a tax savings of up to $500 ($2,000 x 25%
As shown in these scenarios, it pays to be aware of the
Education Savings Bond Program
You may exclude
interest on qualified U. S. savings bonds from your gross income if you have
paid qualified higher educational expenses during the redemption year. When
calculating the amount of higher education expenses paid during the year, you
may include any contribution of the bond proceeds to a Qualified Tuition
Program (QTP) and any contribution to a Coverdell Education Savings Account
(Coverdell ESA) as a qualified expense. You do not qualify for the exclusion if
your filing status is Married Filing Separately or if your modified adjusted
gross income is greater than $87,850 ($139,250 if Married Filing Jointly) in
the year the bond is redeemed.
Contact your neighborhood Jackson Hewitt
office for more information or assistance. Use the Office Locator available on
this Web site or call 1-800-234-1040 to find the Jackson Hewitt location most
convenient to you.