FinAid - Financial Aid Advice The SmartStudent Guide to Financial Aid
Site MapAbout FinAid
 
Loans
Scholarships
Saving for College
Military Aid
Other Types of Aid
Financial Aid Applications
Answering Your Questions
Calculators
Beyond Financial Aid




Advertisement


 
Education Tax Benefit Coordination

Advertisement

IRS rules prevent you from obtaining more than one tax benefit from the same expenses on your federal income tax return. Basically, the idea is to prevent you from double dipping and to limit the basis for your tax benefits to the total amount of qualified higher education expenses.

Advertisement

  • Higher education expenses for four academic years of postsecondary education typically span five tax years. The first tax year contains just the fall semester of the freshman year in college and the last tax year contains just the spring semester of the senior year. This can affect which tax benefits you take in each year, because the higher education expenses will often be lower during the first and last tax years for each student.
  • Each of the education tax benefits has a different income phaseout. Depending on your income, the tax benefits may vary in value. Your best bet is to calculate the potential benefit for each year for each benefit, and pick the set and sequence that yields the maximum benefit for your income level.
  • The American Opportunity tax credit, known now as the American Opportunity, and Lifetime Learning tax credits can be claimed in the same year that you take a tax-exempt distribution from a section 529 plan or a Coverdell Education Savings Account, but the distribution may not be used for the same qualified higher education expenses.
  • Tax-free distributions can be taken from both the Coverdell Education Savings Accounts and a 529 plan in the same year, but the distributions may not be used for the same qualified higher education expenses.
  • You can cash in a qualified US Savings Bond (Series EE issued after December 31, 1989 or Series I) tax free in the same year you take a tax-free withdrawal from a Coverdell Education Savings Account or receive a American Opportunity tax credit or Lifetime Learning tax credit, provided that they are not used for or based on the same qualified higher education expenses. There does not appear to be such a coordination restriction between US Savings Bonds and section 529 plans.
  • The income tax deduction for payment of tuition and related expenses can be claimed in the same year that you make a tax-exempt distribution from a section 529 plan or Coverdell Education Savings Account, but the deduction may not be used for the same qualified higher education expenses.
  • The income tax deduction for payment of tuition and related expenses cannot be claimed for the same student in the same year that you use the American Opportunity tax credit or Lifetime Learning tax credit for that student.
  • You may make contributions to both a Coverdell Education Savings Account and a 529 plan for the same beneficiary in the same year. (If you accidentally exceeded the gift tax exclusion because of your combined contributions to a 529 plan and Coverdell ESA, remember that 529 plans have an accelerated gift option that allows you to average gifts that exceed the limits over a five year period without incurring federal gift tax.)
  • You can claim either the American Opportunity tax credit or the Lifetime Learning tax credits for each child, but not both for the same child in the same year.
  • You cannot use expenses paid using tax-free employer educational assistance as the basis for any other deduction or credit, including the American Opportunity tax credit or Lifetime Learning tax credits and the tuition tax deduction. It is unclear whether this coordination restriction also applies to exclusions from income, such as distributions from Coverdell Education Savings Accounts or 529 plans.
  • For the American Opportunity tax credit and Lifetime Learning tax credits, and cashing in US Savings Bonds tax-free, you must reduce the qualified education expenses by the amount of any tax-free educational assistance received, such as scholarships, Pell Grants, employer-provided educational assistance, and veterans' educational assistance. It is unclear whether this coordination restriction also applies to tax-free distributions from section 529 plans and Coverdell Education Savings Accounts.
  • If you qualify for the American Opportunity tax credit, Lifetime Learning tax credit, and the tuition tax deduction, the American Opportunity tax credit is probably the best of the bunch. If you qualify for only the Lifetime Learning tax credit and the tuition and fees deduction, which is better depends on your education expenses and your tax bracket. The Lifetime Learning tax credit is better for lower income families and for families with at least $4,050 in education expenses. (This threshold increases to $5,400 in 2004.) However, if the tuition tax deduction reduces the family's AGI enough to qualify for the earned-income credit or other AGI-triggered tax breaks, the tuition tax deduction might be better for certain low income families. Similarly, if the family is close to qualifying for the simplified needs test or automatic zero EFC, they may want to consider the impact of the tuition tax deduction on their AGI.

The following chart will help you allocate your qualified education expenses in a manner that maximizes your total tax benefits.

Program
Name
Amount Qualified
Expenses
Income
Phaseouts
Other
Constraints
529 Plans Amount of distribution is not taxed. Higher education expenses. Includes room and board for students enrolled at least half-time (e.g., actual charges from school, or school's official budget for students living off-campus but not at home). None. None.
Coverdell ESA Amount of distribution is not taxed. Higher education expenses including tuition and fees, books, supplies, equipment, and room and board. Room and board are limited to the school's actual charges for students living on campus and $2,500 for students living off campus and not at home. Certain elementary and secondary school expenses may be included. On contributions only. Contributions limited to $2,000 per beneficiary. Contributions phased out between $95,000 and $110,000 (single filers) and $190,000 and $220,000 (married filing jointly). Contributions end at age 18 and must withdraw assets by age 30, unless special needs.
American Opportunity tax credit $1,650 tax credit per student (100% of first $1,100, 50% of next $1,100). Double for Gulf Opportunity Zone students. Capped at amount of tax (not refundable). Higher education expenses, limited to tuition and fees required for enrollment or attendance. Does not include room and board. Single filers: $45,000 to $55,000; Married filing jointly: $90,000 to $110,000. First two years of postsecondary education. Must be enrolled at least half-time in a degree program. No felony drug convictions. Must be able to claim an exemption for the student on your income tax return.
Lifetime Learning $2,000 tax credit per tax return (20% of the first $10,000 paid for all eligible students). Double for Gulf Opportunity Zone students. Capped at amount of tax (not refundable). Higher education expenses, limited to tuition and fees for courses. Single filers: $45,000 to $55,000; Married filing jointly: $90,000 to $110,000. Available for all years of postsecondary education. Does not need to be pursuing a degree. Must be able to claim an exemption for the student on your income tax return.
Savings Bonds Interest on redeemed bonds excluded from income. Higher education expenses limited to tuition and fees. Does not include room and board or non-degree courses. Single filers: $63,100 to $78,100; Married filing jointly: $94,700 to $124,700 (2006 figures, see IRS Form 8815) None.
Tuition and Fees Deduction $3,000 in 2002 and 2003, $4,000 in 2004 through 2007. Tuition Single filers: $65,000 to $80,000; Married filing jointly: $130,000 to $160,000 Must be able to claim an exemption for the student on your income tax return. Adjustment to income, so do not need to itemize deductions.
Interest Deduction $2,500 tax deduction Amount of student loan interest paid for higher education expenses. Higher education expenses include tuition, fees, books, supplies, equipment, room and board, transportation, etc. Single filers: $50,000 to $65,000; Married filing jointly: $105,000 to $135,000. Adjustment to income, so do not need to itemize deductions. Student must have been enrolled at least half-time in a degree program.
Tax-Free
Employer
Educational
Assistance
$5,250 in employer-paid benefits not taxed. Undergraduate and graduate courses, including tuition, fees, books, supplies and equipment. Does not have to be for work-related courses. Does not include courses involving sports, games or hobbies unless required as part of a degree program or related to business of employer. None. Excess also tax free if working condition fringe benefit (i.e., if paid by employee deductible as employee business expense).

Based on this table, there are several rules of thumb for maximizing your education tax benefits:

  • Since the American Opportunity tax credit is a tax credit of at least 50% of the amount of the expenses, it is better than the tax deductions and exclusions from income.
  • Since the Lifetime Learning tax credit is 20% of the amount of the expenses, whether it is better than tax deductions and exclusions from income depends on your tax bracket. If your tax bracket is less than 20%, the Lifetime Learning tax credit is better than the tax deductions and exclusions from income.
  • However, the tuition and fees deduction is taken as an above-the-line exclusion from income. Since this reduces the AGI, it can potentially make you eligible for additional financial aid next year. If that aid is in the form of grants instead of loans, it can potentially make the tuition and fees deduction more attractive than the American Opportunity tax credit or Lifetime Learning tax credit.
  • If you can take either the American Opportunity tax credit or the Lifetime Learning tax credits for a student, prefer the American Opportunity tax credit.
  • The Coverdell Education Savings Accounts and 529 plans may be used for room and board. 529 plans are less restrictive with regard to room and board. Coverdell Education Savings Accounts permit elementary and secondary school tuition expenses, which are not permitted by 529 plans.

The following chart provides additional detail on the type of expenses that qualify for the education tax benefit. It assumes that the student is enrolled at least half-time.

Program
Name
T F B S E L D P M C R&B SN SGH Travel Job
529 College Savings Plans and Prepaid Tuition Plans Y Y Y Y Y           Y Y Y Y  
Coverdell Education Savings Accounts Y Y Y Y Y           Y Y Y Y  
Savings Bonds Y Y                       Y  
IRA Distributions Y Y Y Y Y           Y Y Y Y  
American Opportunity tax credit Y Y                       Y  
Lifetime Learning Tax Credit Y Y                       Y Y
Tuition and Fees Deduction Y Y                       Y  
Education Loan Interest Deduction Y Y Y Y Y Y Y Y Y Y Y Y Y Y  
Employer Tuition Assistance Y Y Y Y Y Y Y Y Y Y Y Y     Y
Itemized Deductions Y Y Y Y Y Y Y Y Y Y Y Y Y   Y
Scholarships Exclusion Y Y Y Y Y                 Y  
Gift Tax Exclusion Y                            
Title IV Federal Student Aid Y Y Y Y Y Y Y Y Y Y Y Y Y Y  

Key:
TTuition
FFees
BBooks
SSupplies
EEquipment
LLoan Fees
DDependent Care
PProfessional Credentials
MMiscellaneous Personal Expenses
CComputer
R&BRoom & Board
SNSpecial Needs
SGHSports, Games, Hobbies
TravelTravel Allowed
JobMust be Job-Related

 

 
Home | Loans | Scholarships | Savings | Military Aid | Other Types of Aid | Financial Aid Applications
Answering Your Questions | Calculators | Beyond Financial Aid | Site Map | About FinAid®
Copyright © 2014 by FinAid Page, LLC. All rights reserved.
Mark Kantrowitz, Founder
www.FinAid.org