With college classes starting throughout the year, it’s important to consider your taxes year-round because there are several tax credits that can help reduce your tax burden. Because these tax credits can lower your tax liability, it’s important to look ahead during the back-to-school rush.
American Opportunity Tax Credit
The government offers some tax credits for parents and college students. The first credit is called the American Opportunity Tax Credit (AOTC). The AOTC is available for the first 4 years of an eligible student’s higher education. In order to be considered an eligible student, you must be pursuing a degree or recognized education credential, be enrolled at least half-time for at least one academic period, not finished the first four years of higher education, not claimed the AOTC for more than 4 tax years, and not have a felony drug conviction at the end of the year.
The American Opportunity Tax Credit offers an annual maximum tax credit of $2,500 per eligible student. If the credit brings your tax to $0, then you may be eligible for a refundable credit of up to $1,000 (based upon 40% of any remaining credit). The full amount of the credit is available to individuals whose modified adjusted gross income is $80,000 or less; or $160,000 or less for married couples filing a joint return.
This tax credit is phased out for households with incomes higher than these levels and is completely phased out when modified adjusted gross income equals $90,000 or $180,000 if you are filing a joint return.
The American Opportunity Credit offers a higher tax credit limit than Lifetime Learning Credit.
Lifetime Learning Credit
The second credit available for qualified education expenses is the Lifetime Learning Credit (LLC). The credit is worth up to $2,000 per tax return and may be available if your modified adjusted gross income is $80,000 or less ($160,000 if you are married filing jointly). The credit is completely phased out when your modified adjusted gross income is $90,000 or more and $180,000 if you’re filing as married filing jointly. The advantage of the Lifetime Learning Credit is there is no limit on the number of years that the credit can be claimed for each student. The credit is available if you are taking one class, not pursuing a degree, acquiring or improving your job skills, or are taking classes as an undergraduate, graduate, or a professional degree course.
529 Savings Plans
Tax-free college savings plans and prepaid college tuition programs can be used for a wide assortment of eligible higher-education expenses such as computer equipment, classroom materials, books, educational supplies, dorm fees, and tuition.
529 plans, or Qualified tuition programs (QTPs), are tuition programs that have been qualified and authorized under section 529 of the Internal Revenue Code. In recent years, they have become a wise and popular way for families to save for a child’s college education. Though contributions to 529 plans are not tax deductible on federal returns, the perks are that there is no income limit for the contributors, your investments grow tax-deferred, and distributions for qualified college expenses are tax-free.
529 plan distributions (money taken out of the account to pay for college-related expenses) are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. It is best to check with your 529 plan account manager and with the IRS to make absolutely sure your expense is qualified.
Qualified expenses include tuition, fees, books, supplies, and equipment required for any apprenticeship programs. Room and board also qualify if the 529 plan beneficiary is at least an official half-time student.
As a side note, up to $10,000 of 529 plan funds can also be used to pay for tuition for private, public, or religious elementary, middle, or high schools.
If your child is already in college, then it’s not going to do much good to start a new 529 plan. However, even if you have a child in high school, you still have time to contribute to a 529 plan and reap some of the benefits.
Filing Taxes
It’s important to get a jump on things because there are so many deductions and tax considerations when dealing with college expenses. The education credit is typically claimed by the parent if the student can be claimed as a dependent. You should receive a Form 1098-T, Tuition Statement, from any institution to which you pay tuition fees. This form is used to claim the education credits on your tax return. Be sure to hold onto this form at tax time.
Many times, the form will be uploaded to the student’s account. If you don’t receive it in the mail, be sure to check with your student. It is also a good idea to keep an ongoing record of your expenses paid for college.
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