What types of tax breaks are available for education costs?
A wide variety of tax relief is available, but you'll need to choose which break(s) to claim or which savings plan(s) to use based on your individual tax situation. You generally can't use two different kinds of relief for the same item. For instance, you can't take a tax credit for expenses that were paid from a tax-advantaged education savings plan or a tax-free scholarship, Pell grant, or employer-provided educational assistance. There may also be limits based on adjusted gross income.
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What are education tax credits?
A tax credit can be an especially valuable tax break because it reduces the actual tax you owe dollar-for-dollar, providing much more tax savings than a deduction of an equal amount. Two tax credits are available for education costs:
American Opportunity Tax Credit (AOTC). This tax break covers 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of expenses. The maximum AOTC, per student, is $2,500 per year for the first four years of postsecondary education in pursuit of a degree or recognized credential.
Lifetime Learning Credit (LLC). If you’re paying postsecondary education expenses beyond the first four years, check whether you’re eligible for the LLC (up to $2,000 per tax return).
If you file married-filing separately, you cannot claim these credits.
Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.
"Related" expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.
If you pay qualified expenses for a school semester that begins in the first three months of next year, you can use the prepaid amount in figuring your credit for this year.
As future year-end tax planning, this rule gives you a choice of the year to take the credit for academic periods beginning in the first 3 months of the year; pay by December and take the credit this year; pay in January or later and take the credit next year.
Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another person's dependent can't claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.
Income limits. To claim the AOTC or the LLC, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). The credits begin to phase out when MAGI hits $80,000 ($160,000 for joint filers). MAGI generally is the same as AGI. The "modifications" only come into play if you have income earned abroad.
Choosing the credit. You can't claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year - for example, an AOTC for your child and an LLC for yourself.
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Do any tax planning considerations apply to education tax credits?
For an academic period (quarter, semester, etc.) beginning in the first 3 months of a calendar year, you can pick which year to pay the expense and take the credit. That is, pay in December and take the credit on this year's return when you file in April, or pay in, say, February of next year and take the credit on next year's return the following April.
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How does a Coverdell ESA work?
A Coverdell Education Savings Accoount (ESA) allows tax-advantaged saving for education expenses. Here are the details:
An ESA may be used for primary and secondary education, including paying for room and board of children in private schools, and for computers and related materials whether or not away from home.
There can be a number of ESAs for any student. Various family members, such as grandparents, aunts, and uncles, and siblings--and persons outside the family--can contribute to separate accounts for a student.
The original student beneficiary for the ESA can be changed to another family member, such as a sibling - for example, if the original beneficiary wins a scholarship or drops out.
Funds can be rolled over tax-free from one family member's ESA to another's, for example, to avoid distribution when the first family member reaches age 30.
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What are 529 plans?
These college savings plans have been established by almost every state and some private colleges. You invest now to cover future college or vocational school expenses by contributing to a savings plan or buying tuition credits redeemable in the future. Investments grow tax-deferred, and distributions to pay qualified postsecondary school expenses are tax free. You may choose any state's plan, regardless of where you live. Funds from 529 plans also can be used for up to $10,000 of elementary and secondary school tuition per year and up to $10,000 of student loan debt per beneficiary.
Even if a 529 plan is used to finance a student's education, the student or the student's parents still may be eligible to claim the AOTC or LLC, as long as expenses paid with the 529 plan distribution aren’t used to claim the credit.
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How do Coverdell ESAs and 529 Plans differ?
Coverdell ESAs limit annual contributions to $2,000 a year per student; 529 plans allow a much larger contributions. Coverdell ESAs allow a wide choice of investments; 529 plan investment choices are limited. Coverdell ESAs are more flexible when it comes to funding elementary and secondary school expenses.
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Can my traditional IRA be used for education?
Yes. The 10% penalty on withdrawal under age 59-1/2 won't apply, but ordinary income tax will apply to at least some of the withdrawal.
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Can a Roth IRA be used for education?
Yes, generally under the same terms as traditional IRAs. Also, ordinary income tax is somewhat less likely or may be smaller in amount, than with traditional IRAs.
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Can I deduct student loan interest?
Personal interest expense generally isn't deductible, but student loan interest expense is deductible, subject to the following limits:
- You must be the person liable on the debt and the loan must be for education only (not an open line of credit).
- Your 2025 MAGI can't exceed $200,000 ($195,000 for 2024) if you're a joint filer or $100,000 ($95,000 for 2024) if you're a single filer. The deduction begins to phase out when 2025 MAGI hits $170,000 ($165,000 for 2024) for joint filers and $85,000 ($80,000 for 2024) for single filers. Married couples filing separately cannot take the deduction.
- You can't be claimed as a dependent on someone else's tax return.
- The maximum deduction is $2,500.
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If I take a home equity loan to pay education expenses, can I deduct the interest?
For tax years prior to 2018, you could deduct interest expense on up to $100,000 of home equity loan debt used to pay educational and other non-home-related expenses. This deduction wasn't subject to the AGI limits that apply to the student loan interest expense deduction. However, for tax years 2018 through 2025, taxpayers are no longer able to deduct interest on home equity loans taken out for non-home-related purposes.
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What tax treatment applies if my student loan debt is canceled?
Forgiven debt is typically treated as taxable income, but tax-free treatment is available for student loan debt forgiven after Dec. 31, 2020, and before Jan. 1, 2026.
Warning: Some states may tax such forgiven debt.
Even after 2025, forgiven student loan debt might be excluded from taxable income in certain circumstances.
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What's the tax relief for education savings bonds?
Interest on redemption of Series EE bonds is tax-exempt if you redeem them in a year you have qualified education expenses. Exemption depends on the amount of your income in the year you redeem the bond.
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Must I pay tax on my employer's payment or reimbursement of my education expenses?
Maybe not. Up to $5,250 can be tax-free. Exemption can apply to graduate level courses.
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Can I take tax deductions for education I pay for that helps me in my work?
For tax years prior to 2018, the answer was, yes, if it was to maintain or improve skills in your present job, but no, if it was to meet minimum requirements of that job, or to qualify to enter a new business. Furthermore, employees' deductions were subject to the 2% of AGI floor on miscellaneous itemized deductions. However, under the Tax Cuts and Jobs Act, for tax years 2018 through 2025, employee business-related deductions (including education expenses) are disallowed. Self-employed individuals are still able to deduct qualifying educational expenses on Schedule C.
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