Education Tax Credits You Can Earn
Education tax credits offer much-needed financial relief for families who are paying educational expenses. Opportunities like the Lifetime Learning Credit, the American Opportunity Credit, and the Tuition and Fees Deduction can save families thousands of dollars. But the first step to taking advantage of these opportunities is to learn how they work. Many families aren’t even aware that they can claim education tax credits.
Since families can only claim one of these credits per year, it’s important to choose the most beneficial one. Let’s go over the rules and benefits of each education tax credit. We’ll describe who qualifies and how it can be used. You can use this information to determine which opportunity is the most beneficial for you.
Tax deductions versus credits
In order to determine which credit to claim, it’s important to have a thorough understanding of how tax deductions work. Deductions allow you to deduct a sum from your taxable income. In other words, you will be exempt from paying income taxes on the sum that you deduct.
For example, let’s say that you deduct $2,000 from your federal taxes. If you were taxed 10% on that income, you would receive that 10% back. That’s $200 saved from your education tax credit. So, in order to find the best education tax credit, find the one that gets you the highest deduction. And remember – if your educational expenses were less than the maximum deduction, you cannot claim the entire sum.
Tax credits are a bit simpler. If you claim a tax credit, you will receive the entire sum of that credit. It will either be used to reduce the taxes you owe, or sent to you as a refund. However, some credits are non-refundable. This means that you can only claim them if you owe taxes. If you don’t, you will not receive the money as a payment from the IRS.
Learn more: Are work study earnings taxed?
Can you use tax credits for loans?
It’s a common misconception that you cannot claim educational tax credits for student loans. If you take out student loans, you can claim a credit or deduction on that sum. So, even if you did not pay $4,000 out of pocket towards tuition, you can claim $4,000 for credits.
Even if you are paying back loans, education tax credits can come in handy. Many students can deduct student loan interest payments from their taxable income. If you paid over $600 in interest that year, your servicer will send you the necessary tax form. This form is the 1098-E. However, you are eligible for the deduction even if you didn’t pay $600. You’ll just have to reach out to your servicer for a copy of the form.
Lifetime learning credit
The lifetime learning credit is the most flexible education tax credit in its definition of educational expenses. These expenses are not limited to students who are pursuing an undergraduate. Expenses towards graduate school, trade school, and even non-degree educational programs are eligible. Tuition, fees, books, and course materials can all be deducted under the credit.
However, there are income-based limits on who can claim the Lifetime Learning Credit. Your modified adjusted gross income, or MAGI, must be below $69,000 for the year. This limit is increased to $138,000 per year for couples who file jointly.
What is the maximum credit?
The Lifetime Learning Credit can be used to claim 20% of up to $10,000 in educational expenses. This means that you can receive up to $2,000 per year. However, if your MAGI is over $59,000, your maximum deduction will decrease. The closer you get to the limit of $69,000, the less you will be able to deduct.
Is it refundable?
No, the Lifetime Learning Credit is not refundable. As a result, you can only use the credit to reduce the amount you owe. If you don’t owe anything, you cannot get it back as a refund.
American Opportunity Credit
Anyone with a qualifying MAGI who paid for undergraduate education expenses during the tax year can claim this credit. You must have a MAGI below $90,000 (or $180,000 if filing jointly with a spouse) to qualify. You’ll only be able to claim this credit for up to four years per student. But if you have multiple undergraduate students at once, you can claim it for each of them.
What is the maximum credit?
You can claim up to $2,500 per year with this credit. However, there is a caveat for claims over $2,000. Taxpayers can claim the entirety of their first $2,000 in expenses, but only 25% of the next $2,000. So, if you only paid $3,000 total that year, you would only receive a $2,250 refund. That’s the entirety of the first $2,000 plus 25% of the next $3,000.
Additionally, eligibility for the credit begins to phase out if your MAGI is $80,000 or above (or $160,000 for couples filing jointly). If your MAGI is above $80,000, your maximum credit will begin to decline. The closer your MAGI gets to $90,000, the closer your maximum credit will get to $0.
Is it refundable?
Yes, the American opportunity credit is refundable. As a result, you can receive up to 40% of its value as a tax refund. This would occur if you didn’t owe taxes at the end of the year.
Tuition and Fees Deduction
The Tuition and Fees Deduction has a long history of being discontinued, restarted, and modified. It most recently expired at the end of 2020. As of June 2021, it is suspended. However, there is a good chance that it will be reinstated in the next few years. Importantly, when it is in effect, taxpayers can apply it retroactively to past years’ taxes. So, if this is the best fit for you, you can utilize it on taxes as far back as 2017.
The deduction commonly goes through modifications when it is reinstated. As a result, it may not look the same when and if it is reissued. But in order to give you a picture how the deduction works, here are the details from its last iteration:
Anyone who paid educational expenses with a MAGI below $65,000 qualified in 2020.
What is the maximum deduction for the Tuition and Fees Deduction?
In 2020, the Tuition and Fees Deduction had a maximum deduction of $4,000. It’s important to remember this is a deduction and not a credit. So, people were exempt from income tax on up to $4,000 in income. They did not receive a $4,000 credit.
Forms to look out for
The most important form for claiming education tax credits is the 1098-T. This tax form shows all the educational expenses paid to the school. Your school will distribute these every January. If you are claiming credits for textbooks and other course materials, you’ll need receipts for those as well. If you want to deduct student loan interest payments, you’ll also utilize the 1098-E. Your servicer will send this to you if your payments exceeded $600. If they did not, you will have to request it.
Now that you have information about each tax credit, it’s time to examine your financial situation. The first step should be to check your MAGI. You’ll want to check if it qualifies you for any of the opportunities. For example, someone with a MAGI of $62,000 would qualify for the entire American Opportunity Credit. However, they would only qualify for a partial Lifetime Learning Credit; $62,000 is in the phase-out range.
Next, you’ll want to account for your educational expenses. Check whether they qualify for any of the credits. For example, undergraduate tuition payments would qualify for any of the credits. Graduate school tuition payments would qualify you for the American Opportunity Credit. Transportation expenses would not qualify for any of the credits.
Now you’ve determined which credits you qualify for and which give you the biggest tax break. The next step is to gather the forms from your school and/or loan servicer. You’ll need the information on these forms to claim your credit come tax time. Good luck! And don’t forget to investigate other tax opportunities for education expenses, such as a 529 Plan.