Last Modified on January 20, 2021

When it comes to college education, the costs involved can be overwhelming. Right from the tuition money to the cost of travel, books, course-related equipment and more, parents and students often have to turn to student loans to accommodate these expenses. While long-term savings accounts, such as a 529 education account, Individual Retirement Account (IRA), etc. can make things easier for parents and students, there are other ways to reduce the overall expenses too. Education tax credits ease some tax liability for both parents and students and make for a great tax strategy.

What are education tax credits?

Education tax credits are a unique form of tax credit that tax payers can claim for paying qualified educational costs, such as college fee, cost of books, supplies, etc. These costs should be for a post-secondary school like a college or university. There are two types of education tax credits:

• American Opportunity Education Credit: This form of education tax credit allows you to save up to $2,500 in taxes. This credit is available to students in the first four years of their post-secondary course. In addition to this, students need to enroll at a school that qualifies for the federal student aid program.
• Lifetime Learning Credit: This credit can be availed by people of different ages and educational backgrounds and can be claimed at any year of the degree or course. This credit allows you to save up to $2,000 in taxes.

Here are 6 important pointers to know about education tax credits:

1. Understanding the American Opportunity Education Credit

The American Opportunity Education Credit can be availed if the student goes to a college, university, non-profit institution, or vocational institution. 40% of this credit is refundable even if you have no tax liability at all. However, in order to claim the credit, the student should have enrolled at least half time for one academic course in the financial year when the tax is being filed. This credit can be claimed for educational expenses for yourself, your spouse, or your dependent children. Room expenses and boarding costs are not included in the list of qualified expenses. However, you can consider tuition fees, cost of books, supplies, course-related equipment, etc. Another vital thing to remember about this tax credit is that if any felony charges are found against the student, the American Opportunity Education Credit can no longer be availed of.

2. Understanding the Lifetime Learning Credit

The Lifetime Learning Credit can be used by a broader range of students as compared to the American Opportunity Education Credit. While the latter is only eligible to students pursuing post-secondary education, the former can be availed by students pursuing undergraduate, graduate, post-graduate, as well as professional courses and degrees. Since there is no time limit to avail this credit, even adults pursuing studies at a later stage in life can qualify for this tax credit. As opposed to the American Opportunity Education Credit, this credit is not refundable. But you can claim it for yourself, your spouse, or a dependent child. Unlike the other credit, even a student charged with a felony can claim this credit. The credit can be used for expenses, such as buying books, supplies, equipment, etc., but boarding expenses and room rent are not included.

3. Only one credit can be claimed in a year for one student

One tax payer can only claim one credit for one student in a year. So, if you claim the American Opportunity Education Credit for one child, and you have another child, you will have to claim the Lifetime Learning Credit for the second kid. Since the rules of eligibility and offerings of these credits differ, you can choose which one is more suitable for each of your children and make an appropriate decision.

4. The eligibility criteria for claiming education tax credits may differ each year

The eligibility criteria to claim education tax credits are decided by the Internal Revenue Services (IRS) for every financial year. As of 2020,

• For individual tax payers, the modified adjusted gross income (MAGI) should not be more than $80,000. If your MAGI is more than $80,000, but under $90,000, you can qualify for a lower credit amount. However, you cannot claim any credit with a MAGI of more than $90,000.
• For married individuals filing jointly, the modified adjusted gross income (MAGI) should not be more than $160,000. If your joint MAGI is more than $160,000, but under $180,000, you can qualify for a lower credit amount. However, you cannot claim any credit with a joint MAGI of more than $180,000.

5. Form 8863 should be submitted to claim the credit

In order to claim any of the two credits, you need to fill the Form 8863 and submit it with your income tax return form. The form requires information, such as the student’s name, Social Security number, address, etc. You also need to calculate the total credit amount and enter it in the form before submitting it.

6. An education tax credit is different from a tax deduction

A lot of people assume that a tax credit is the same thing as a tax deduction. However, these two play varying roles in your income tax return. Tax deductions primarily depend on your total tax liability. They are calculated as per the income tax margin you fall into. Thus, if your income increases, your tax liability also increases. Tax credits, on the other hand, can reduce a person’s liability as they are directly deducted from the total tax dues. These can also be refundable. For instance, the American Opportunity Education Credit is refundable up to 40% even if you have no tax due.

To sum it up

Getting the education you need and deserve is a hard goal to achieve in today’s times. With the rising costs of education in the country, it is becoming increasingly hard for parents and students to cover education-related expenses. Moreover, with growing competition in the professional world, taking up a student loan can be a tough option. However, education tax credits bring in some aid to tax payers in this arduous journey.

If you need to know more about higher education planning or need help reducing your tax liabilities, you can get in touch with a professional financial advisor in your area.