6 Tax Benefits of Going To College

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One of the reasons that the U.S. Tax Code is so lengthy is that it is chock full of deductions, credits and other tax modifications designed to support and encourage certain types of behavior.

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As higher education is widely seen as a societal good, the U.S. government offers a wide variety of tax benefits for going to college, both for students and for parents. Here are some of the most important and commonly used, plus 10 tax deductions you should know as you file taxes this year

Student Loan Interest Deduction

The student loan interest deduction is one of the most powerful write-offs you can get because it is an “above-the-line” deduction. This means you can take it right off your income, even if you do not itemize your deductions.

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The student loan interest deduction allows qualifying taxpayers to deduct as much as $2,500 of their interest expense on loans used to pay for higher education expenses. Although modified adjusted gross income limits of $80,000 for singles and $160,000 for joint filers apply, the deduction can be taken on loans for a taxpayer, a spouse or any qualifying dependents.

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529 Plans

College savings plans, also known as 529 plans, provide for the tax-free growth of investments and tax-free withdrawals of funds used for qualifying educational purposes. You won’t get a federal tax deduction for your contributions, but you may qualify for state tax benefits, especially if you live in the same state where the 529 plan is domiciled.

Coverdell Education Savings Account

Coverdell Education Savings Accounts were the precursors to 529 plans, but have faded a bit in prominence relative to those newcomers. As with 529 plans, your investments in the account will grow tax-free, and your distributions will be nontaxable when used for college costs. But the maximum that you can contribute in any one year to a Coverdell ESA is $2,000.

American Opportunity Credit

The American Opportunity Credit is one of the best and most popular tax benefits of going to college. This credit tops out at $2,500 for qualified education expenses you pay for each eligible student, in the form of 100% of your first $2,000 in expenses and 25% of the next $2,000 that you spend.

The credit is partially refundable, meaning if your tax liability is zero, you can still claim 40% of your qualifying credit, up to $1,000, in the form of a tax refund. Modified adjusted gross income limits of $90,000 for singles and $180,000 for joint filers apply to the American Opportunity Credit.

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Lifetime Learning Savings Credit

The Lifetime Learning Savings Credit is similar to the American Opportunity Credit, but with a few important differences. Both offer credits for qualifying higher education expenses; but, whereas the AOC is limited to the first four years of post-secondary education, the LLSC has no limitation in terms of years. In other words, if you, your spouse or child continue into graduate school, the LLSC will still apply.

The Lifetime Learning Savings Credit is limited to $2,000 per year, and it is nonrefundable. This means if you have no tax liability, you won’t be able to benefit from the credit. Other differences between the two credits are relatively minor. 

The same MAGI restrictions that apply to the AOC apply here as well ($90,000 for singles and $180,000 for joint filers). Note that you won’t be able to “double up” your credits — you can claim both credits on a single tax return, but not for the same student or for the same expenses.  

IRA Withdrawals

IRAs aren’t generally considered education-related accounts, but the IRS does allow you to take penalty-free withdrawals from an IRA if the money is used for higher education purposes. Unless another exception applies, money withdrawn from an IRA before age 59½ generally incurs a 10% early withdrawal penalty. Even if the money is used for educational purposes, however, you will have to pay ordinary income tax on your distributions.

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With a Roth IRA, the same rules apply, although there’s an extra trick available that might help those in need of educational funding: Your Roth contributions can be withdrawn tax- and penalty-free at any time. Your earnings may be subject to taxation; but, if you stick to your contributions, you can take that money out at any time.

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About the Author

After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.
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