Tax Credits Help Take the Sting Out of Higher Ed Costs

February 22, 2016

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The following is for informational purposes only and should not be considered advice. If you need tax advice, please see your tax professional.

The tax system used to be a complete mystery to me. Whether I received a refund or had to write a check in April appeared arbitrary and out of my control. Sometimes I won, sometimes I lost. I never understood why. Last year I decided that I was not going to be uninformed anymore. I began with decoding my paystub, searching for the meaning behind each line item. (I encourage everyone to do the same.)

The more I discovered about taxes, the more they made sense to me. I spent hours working different scenarios, trying to find the ideal tax strategy for myself. Then I came across the education tax credits. The federal government offers two tax credits to decrease the sting of higher education costs. These credits reduce the amount an individual owes in taxes if they pay for college. Depending on where you are in your educational career, your income, and the cost of school, these credits may put money back in your pocket.

Some credits are refundable and some are not. If a credit is refundable, and you end up owing no taxes, a portion of this credit can be used to give you a refund. If a credit is non-refundable, and you end up owing no taxes, you would not receive a refund by using the credit. It can be complicated and it’s important to know the differences between the two.

American Opportunity Tax Credit (AOTC)
This credit can be claimed by an individual to decrease their federal taxes if they paid for themselves, their spouse, or their dependent(s) to attend up to four years of a post-secondary program. Typically, tax payers utilize this credit before the lifetime learning credit. AOTC is worth a maximum of $2,500 per year and 40 percent of the AOTC is refundable.

The following requirements must be met before one can take advantage of the AOTC:

  • The credit can only be used for four years—the first four years the student attends college.
  • The student must be working toward a degree or credential.
  • The student must be enrolled at least half time.
  • The credit covers tuition, mandatory enrollment fees, books, and required course materials.
  • The credit cannot be used if funds came from scholarships, Pell Grants, or a college savings plan (i.e. 529 or Coverdell).
  • The credit cannot be applied to money spent on room, board, or health insurance.
  • The student must be enrolled at an eligible institution (e.g. the majority of accredited public, private, and for-profit schools).
  • The student’s income level can reduce the credit or make it unusable.
  • The credit cannot be used in addition to a lifetime learning credit (see information on this tax credit below).
  • The student cannot have a felony drug conviction.

­­­Lifetime Learning Credit
This credit benefits people who are in a graduate program, have more than four years of college credit, or are leisurely taking classes. Like the AOTC, it can also be used if you paid for school for a spouse or dependent(s). The lifetime learning credit is smaller than the AOTC with a maximum of $2,000 and is entirely non-refundable. In other words, it can be used to reduce your taxes owed, but will not increase your refund the way that the AOTC can.

The following requirements must be met before one can take advantage of the lifetime learning credit:

  • There is no limit to how many times an individual can claim the lifetime learning credit.
  • This credit can only be used for funds that paid for tuition, required fees, books, and materials.
  • The student must be enrolled at an eligible institution (e.g. the majority of accredited public, private and for-profit schools).
  • This credit cannot be applied to money spent on room, board, or health insurance.
  • The student’s income level can reduce the credit or make it unusable.
  • This credit cannot be used in addition to the AOTC.

Your tax professional or software should be aware of these credits and if you’re eligible. The IRS has this handy calculator to help you out.

The best thing you can do is to familiarize yourself with both credits if you or your dependent(s) are in school or plan to be. I’m still on the fence about my educational future but at least I know my options and have a better idea of how my choice will affect my taxes.