Federal Tax Benefits Overview

"Federal Tax Benefits Overview" submitted by SchoolGrantsfor Editorial Team and last updated on Monday 9th January 2012

A tax credit is an amount that you’re allowed to subtract from what you owe in taxes. When you pay college costs, you can subtract a certain amount from your tax bill later on. If your parents pay college expenses for you, they get the tax credit.

In addition to loans and grants, the federal government offers a series of tax benefits for education. Most of these benefits are for students and their families to reduce the cost of higher education, but the federal government also offers a few benefits related to K-12 education.

There's great news for parents and students: the federal government provides a number of tax incentives that can help defray the cost of higher education. These incentives come in a couple of forms:

Get some federal income tax relief on money spent on education-related expenses. These benefits are available to part-time students, full-time students, married students, and parents of dependent students. You may qualify to use more than one of the benefits, but there are some restrictions against this as well. It's a good idea to figure your taxes multiple ways so you can get the maximum benefit available to you.

There are four tax benefits for higher education: two credits and two deductions and there are twelve higher education-related tax benefits included in the Internal Revenue Code. The amount of the credit varies and is subject to a number of rules, depending on which credit you use, what you use the money for, and what area of the country you live in. Your family may not claim more than one credit for the same student in any one year.

There are twelve higher education-related tax benefits included in the Internal Revenue Code. Six of these benefits,

  1. the American Opportunity Credit;
  2. Lifetime Learning Credit;
  3. the Tuition and Fee Deduction;
  4. the Student Loan Interest Deduction;
  5. Coverdell Education Savings Accounts; and
  6. Qualified Tuition Program (529 Plans), are discussed in detail below.

Other federal higher education tax benefits include:

  1. the tax-free status of scholarships, fellowships, grants, and tuition discounts for degree candidates;
  2. the tax-free value of student loan cancellations;
  3. the education exception to taxation on early withdrawals from individual retirement accounts;
  4. the Education Savings Bond Program (if savings bonds are cashed in for education expenses, the bond is not included in taxable income);
  5. the tax-free value of employer-provided education assistance; and finally
  6. the business deduction for work-related education expenses.

The Hope Scholarship Tax Credit provides up to $1,500 in tax credit for freshmen and sophomores. The Lifetime Learning Tax Credit provides a tax credit of up to $2,000 per family for anyone in college. The Tuition and Fees Tax Deduction allows you to deduct up to $4,000 tuition and fees. The Student Loan Interest Tax Deduction allows you to deduct up to $2,500 in student loan interest depending on your income.”

Difference Between Hope & Lifetime Learning Tax Credit, Student Loan Interest, Tuition & Fees Deduction, Coverdell (ESA) and 529 (QTP) College Savings Plans:

  American Opportunity Tax Credit (a.k.a. Hope Tax Credit) Lifetime Learning Tax Credit Student Loan Interest Deduction Tuition and Fees Deduction Coverdell Education Savings Account 529 College Savings Plans (Qualified Tuition Plans)
What is it? The American Opportunity Tax Credit [AOTC] can be claimed for four post-secondary education years (instead of two, as with the Hope Credit). However, the AOTC is for amounts paid in 2009 and 2010 only. A tax credit for tuition and qualified expenses for higher education or career training. A tax deduction of up to $2,500 of the interest you pay on your student loan each year, or the interest you pay on loans you received for your spouse’s or child’s education. A tax deduction of up to $4,000 for tuition and fees from your taxable income if you are not eligible for the Hope or Lifetime Learning tax credits. A savings account that is set up to pay qualified education expenses for a designated beneficiary. The beneficiary must be under the age of 18 or a special needs beneficiary. An account that is set up to let you save for or prepay your or another beneficiary’s college costs. Each plan has its own annual and total contribution limits.
Income Limits Taxpayers with a modified adjusted gross income of less than $90,000 (less than $180,000 if married and filing jointly). The credit is gradually reduced for those with incomes between $80,000 – $90,000  ($160,000 –$180,000 if married and filing jointly). Taxpayers with a modified adjusted gross income of less than $60,000 (less than $120,000 if married and filing jointly). The credit is gradually reduced for those with incomes between $50,000 – $60,000 ($100,000 –$120,000 if married and filing jointly). Taxpayers with a modified adjusted gross income of less than $75,000 (less than $150,000 if married and filing jointly). The credit is gradually reduced for those with incomes between $60,000 – $75,000 ($120,000 –$150,000 if married and filing jointly). Taxpayers with a modified adjusted gross income of no more than $65,000 (no more than $130,000 if married and filing jointly) may deduct up to $4,000. Those with incomes of more than $65,000 (more than $130,000 if married and filing jointly) but not more than $80,000 ($160,000 if married and filing jointly) can deduct up to $2,000. Taxpayers with a modified adjusted gross income of less than $110,000 (less than $220,000 if married and filing jointly) can  contribute to a Coverdell account. There are no income restrictions on individual contributors.
Enrollment Status/ Types of Classes Eligible First two years of undergraduate (status as of January 1). You must be enrolled at least half time in an eligible program leading to a degree or certificate for at least one academic period beginning in 2009. Undergraduate, graduate, and individual job-related courses. You can be enrolled in an eligible post secondary institution, or in any course of instruction at an eligible school to improve or acquire job skills. You do not need to be pursuing a degree or other recognized education credential. Undergraduate, graduate, and individual courses You must have been enrolled at least half time in a degree program during the time of the loan. Undergraduate and graduate. You must be enrolled in at least one course at an eligible post-secondary institution. K-12, undergraduate, graduate. You can make tax-free withdrawals for qualified higher education expenses when the beneficiary is enrolled at an eligible post-secondary school. For undergraduate and graduate. The beneficiary must be taking at least one course at an eligible post-secondary institution to make tax-free withdrawals.
Benefits You can subtract up to $2,500 a year of your—or your spouse’s or your child’s—college costs (100 percent of the first $2,000 you pay for tuition and qualified expenses, and 25 percent of the next $2,000, for each student) from the federal tax you owe. Even families whose tax liability is less than the credit amount can receive a refund of up to 40 percent of the credit amount they’re eligible to receive (up to $1,000).* Enables candidates for a degree at an eligible educational institution to deduct certain types of scholarship and fellowship income (used for tuition, fees, and other qualifying education expenses) from their federal taxable income. You can subtract up to $2,000 a year of your qualified education expenses, or those of your spouse or child (20 percent of qualified costs up to $10,000) from the federal tax you owe.* No limit on the number of years the credit can be claimed. If you qualify for both the Hope and Lifetime Learning tax credits, you can claim only one. Enables individuals to claim an income tax credit for qualifying education expenses paid for students enrolled in eligible educational institutions. The deduction will reduce the amount of your income that may be taxed by up to $2,500. You can claim this deduction even if you do not itemize deductions on your federal tax return. Exempts certain types of student loan repayment assistance—including cancelled (forgiven) loans—from gross income (for tax purposes). Enables qualifying students to deduct from their federal taxable income up to $2,500 of interest payments made on student loans. Depending on your income, you can deduct up to $4,000 of your tuition and fees (if you are not claimed as a dependent by another taxpayer) or those you paid for your child’s or spouse’s education. You do not have to itemize to take advantage of this tax benefit but you must complete Form 8917 and file it with Form 1040 or 1040A. Allows certain individuals to deduct from their federal taxable income up to $4,000 of qualifying educational expenses for tuition and fees. Total contributions for the beneficiary in any year cannot be more than $2,000. The amount of withdrawals you can make in a year cannot be more than actual qualified education expenses. For undergraduate and graduate. Contributions and earnings grow tax-free and you pay no federal taxes when you withdraw money for qualified education expenses. QTPs, also called“529 plans,” are programs set up to allow individuals to either prepay, or contribute to an account established for paying, a student's qualified education expenses at an eligible educational institution.

Information Is Important

Remember to save your records of all education related payments and financial aid for tax purposes. Colleges and universities will need to collect Social Security numbers from all students so they can issue information reports to assist you in preparing your tax returns. Institutions are required to provide Form 1098-T, Tuition Payments Statement, to students from whom or on whose behalf they receive tuition payment (with the exception of continuing education students and nonresident alien students). Banks, institutions, and other lenders that collect student loan interest payments must issue annual information returns—Form 1098-E, Student Loan Interest Payments—to individuals from whom they collect more than $600 in interest during the tax year. Although you do not need to have or include a copy of these forms with your tax return to take advantage of the education credits or deductions, these records can assist you in determining your qualified education expenses for the year. For more information: IRS Publication 970, Tax Benefits for Higher Education, and Publication 520, Scholarships and Fellowships, are available from the IRS Web site at www.irs.gov or by calling 1-800-TAX-FORM .

A higher Hope or Lifetime Learning tax credit may be claimed for students attending graduate and undergraduate institutions in a Midwestern disaster area using the 2008 rules. For more information, visit www.irs.gov and view Publication 4492-B.

You may be able to take advantage of a number of federal tax benefits, including credits, deductions and savings incentives, to offset your costs for college or career training. Teaching taxes can take a traditional approach as students complete downloaded worksheets, classroom activities, and assessment pages. Or, students can complete work online and take part in interactive activities and simulations. You will find details on all the tax benefits at the Internal Revenue Service Web sites listed below. It is highly recommend you consult a professional tax advisor or attorney.

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