With the college application process winding down for the 2011 fall semester, this is a good time to review some of the tax breaks your children’s higher education might offer you for your 2010 return.
The American Opportunity Credit (this replaced the Hope Credit) - offers a dollar for dollar reduction in your taxes up to $2500. This is the distinction between a credit and a tax deduction which only reduces your taxable income. Further, up to 40% ($1000) is refundable, which simply means you can get money back even if your tax bill for the year is zero. This credit has a phaseout, for married filing joint, the credit decreases from $160,000 modified adjusted gross income (MAGI) to $180,000 MAGI at which point, there is no credit. Consider this for a moment – this has the effect of taking this $160K-$180K income spread and making it an effective 40.5% bracket as $2500/$20000 is 12.5% and this range falls within the 28% normal tax bracket. For the single parent, the phaseout range is from $80,000 to $90,000 MAGI and the decisions regarding deductions or addition to income when in this range are even more sensitive.
The Lifetime Learning Credit – is also a credit, but only applicable to the extent taxes are otherwise owed, i.e. it’s not refundable, and limited to $2000 per year. It has lower phaseouts, $100,000-$120,000 for married, $50,000-$60,000 if single. While the American Opportunity Credit could only be used for the first four years of undergraduate study, the Lifetime Learning Credit can be applied for graduate learning as well as courses to acquire or improve job skills. Want more info? Watch a short video on the Lifetime Learning Credit.
Tuition and Fees – if neither of the above help you, you might be able to take a deduction off your income for tuition and fees. This option offers a $4000 deduction and you do not need to itemize to take advantage of it. Instead you fill out Form 8917 and submit with your 1040. The income limit for this deduction is $160,000 if married, $80,000 if single, but it’s not scaled as the credits are, there are thresholds, and your deduction allowed is $2000 or $4000 maximum, if any. Of course, if the tuition and fee total was lower, that’s the limit of this deduction.
Interest Loan Deduction – As with the tuition/fee deduction, interest on student loans can offset your taxable income without needing to itemize. Up to $2500 of interest may be deducted with a MAGI limit of $150,000 married, $75,000 single.
Important to note, the above are not cumulative, you should review the rules regarding each benefit and take the one most advantageous to you.
To help pay for higher education, you may need to tap your IRA. While early withdrawals are typically subject to a 10% penalty, withdrawals for this purpose are only taxed as income, no penalty. This is to pay for qualified education expenses for you, your spouse, your children or spouse’s children or any of your descendants.
If you or your children were in college in 2010, don’t miss the potential tax savings available to you. Leave of a comment if this article helped you find a deduction you may have not otherwise known about.