There are several education tax breaks to help taxpayers pay for college. These include the American Opportunity Tax Credit (AOTC), Lifetime Learning Tax Credit (LLTC), Student Loan Interest Deduction, Education Savings Bond Program, Coverdell Education Savings Accounts and 529 College Savings Plans.
Some of these tax breaks involve tax credits and some involve an exclusion from income, often called a deduction. Each tax break has different eligibility restrictions and different definitions of eligible expenses. Some of the requirements are adjusted annually for inflation and some are not.
Eligibility for Tuition Tax Credits
There are two tax credits which are based on amounts spent on tuition and fees, books, supplies and equipment for a student who is either the taxpayer, the taxpayer’s spouse, or a dependent claimed by the taxpayer on their federal income tax return. Other college costs, such as room and board or transportation, do not qualify.
- The American Opportunity Tax Credit (AOTC) provides a partially-refundable tax credit worth up to $2,500 based on 100% of the first $2,000 in qualified expenses and 25% of the second $2,000 in qualified expenses. Up to $1,000 (40%) of the tax credit may be refunded, except to certain taxpayers who are under age 24 as of the end of the tax year. The AOTC is limited to the first four years of postsecondary education and to four tax years for each student. It is mostly used for undergraduate students. The student must be seeking a degree or certificate and enrolled on at least a half-time basis. Expenses paid for academic periods that begin during the first three months of the next tax year may be counted as occurring during the current tax year if the expenses were paid during the current tax year. The student must not have been convicted of a federal or state felony for the sale or possession of controlled substances. Students cannot claim the tax credit for themselves if they are claimed as a dependent on someone else’s federal income tax return (eg, their parent’s tax return). The AOTC can be claimed for qualified expenses that were paid with student loans. Qualified expenses are otherwise reduced by tax-free educational assistance received for the same expenses.
- The Lifetime Learning Tax Credit (LLTC) provides a non-refundable tax credit worth up to $2,000 base don 20% of the first $10,000 in qualified expenses. The LLTC is available for an unlimited number of years, and is often used for graduate students and continuing education. The student does not need to be enrolled on at least a half-time basis.
Coordination restrictions claiming to prevent both the AOTC and LLTC for the same student in the same year.
Both tax credits have income phaseouts of $80,000 to $90,000 for single filers and $160,000 to $180,000 for married filing jointly. Married taxpayers who file as married filing separately are ineligible. The income phaseouts for the American Opportunity Tax Credit and Lifetime Learning Tax Credit are not adjusted for inflation.
Eligibility for the Student Loan Interest Deduction
The student loan interest deduction provides an above-the-line exclusion from income for up to $2,500 in interest paid on qualified education loans. Qualified education loans include all federal student loans and most private student loans.
The borrower must not be claimed on someone else’s federal income tax return. The taxpayer must have been legally obligated to pay the interest on the student loan. Interest paid by others is counted as though it was paid by the borrower.
The student loan interest deduction has income phaseouts of $75,000 to $90,000 for single filers and $155,000 to $185,000 for married filings jointly. Married taxpayers who file as married filing separately are ineligible.
Eligibility for the Education Savings Bond Program
Interest on qualified education savings bonds is tax-free when redeemed to pay for qualified education expenses or rolled over into a 529 college savings plan, prepaid tuition plan or Coverdell education savings account. Qualified education expenses include tuition and required fees.
The qualified education expenses must have been paid for the education of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent. The beneficiary of the 529 plan, prepaid tuition plan or Coverdell must be the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent. The qualified expenses are reduced by the amount of tax-free education benefits, the AOTC or LLTC, uses for the same expenses.
Qualified education savings bonds include Series EE US Savings Bonds issued in 1990 or a later year and Series I US Savings Bonds. The savings bonds must have been issued in the taxpayer’s name, who must have been at least 24 years old before the bond issue date.
To qualify for interest-free treatment, the bond holder must have income under income phaseouts of $91,850 to $106,850 for single filers and $137,800 to $167,800 for married filing jointly in the year during which you cash in the bonds or roll them over into a 529 plan . Married taxpayers who file as married filing separately are ineligible.
Eligibility for Coverdell Education Savings Accounts
Earnings within a Coverdell education savings account and distributions to pay for qualified education expenses are tax-free. Qualified education expenses include qualified higher education expenses and qualified elementary and secondary education expenses.
- Qualified higher education expenses include tuition and fees, books, supplies and equipment, computer equipment, peripherals, Internet access and software, room and board (if enrolled at least half time), as well as expenses for special needs services.
- Qualified elementary and secondary education expenses include tuition and fees, books, supplies and equipment, academic tutoring, computer equipment, peripherals, Internet access and software, room and board, uniforms, and transportation, as well as expenses for special needs services.
The annual contribution limit is $2,000 (combined) from all sources for all Coverdell education savings accounts for the same beneficiary. Excess contributions are subject to a 6% excise tax. Contributions must end when the beneficiary reaches the age of 18, unless the beneficiary is a special needs beneficiary. The Coverdell education savings account must be fully distributed within 30 days after the beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary, or the beneficiary dies.
Contributors to a Coverdell education savings account are subject to Income phaseouts of $95,000 to $110,000 for single filers and $190,000 to $220,000 for married filing jointly. Contributors who file as married filing separately are ineligible. The income phaseouts for the Coverdell education savings accounts are not adjusted for inflation. (Contributions may also be made by corporations, trusts and other organizations, without regard to income.)
Coverdell education savings accounts may be rolled over into a 529 college savings plan, but not vice versa.
Eligibility for 529 College Savings Plans
Earnings within a 529 college savings plan and distributions to pay for qualified higher education expenses are tax-free.
Qualified higher education expenses include tuition and fees, books, supplies and equipment, computer equipment, peripherals, Internet access and software. room and board (if enrolled at least half-time), and as well as expenses for special needs services. Qualified expenses also include up to $10,000 per year in elementary and secondary school tuition, expenses for certain apprenticeship programs (fees, books, supplies and equipment), and up to $10,000 in student loan repayment (lifetime limit per borrower) for each of the beneficiary and the beneficiary’s siblings.
529 plans have no income phaseouts and no age limits. 529 plans have no annual contribution limits, other than gift tax considerations. The annual gift tax exclusion is $17,000 in 2023. Five-year gift-tax averaging, also known as superfunding, can be used to make a lump-sum contribution equal to five times than annual gift tax exclusion and will be treated as occurring over a five-year period. Aggregate limits vary by state.