tuition tax credit

Tuition Pain? This Tax Credit Can Help

Updated June 2023

Key Takeaways:

  • Tax deductions reduce your tax bill by lowering your taxable income whereas tax credits reduce your tax bill directly by a set dollar amount.

  • Modified Adjusted Gross Income (MAGI) is your gross income with the consideration of specific tax credits and deductions.

  • The American Opportunity Tax Credit is a refundable education tax credit that offers qualifying students $2,500 toward eligible education costs.

  • The Lifetime Learning Credit is a non-refundable tax credit that offers qualifying students up to $2,000 toward eligible education expenses every tax year.

  • Tuition and fees deduction allows qualifying students to deduct up to $4,000 for their qualified tuition and expenses when enrolled at an eligible institution.

  • Student loan interest deduction allows eligible students to deduct the lesser of $2,500 or the amount they actually paid in student loan interest.

Being a student in higher education is expensive. With the cumulative costs of tuition, fees, housing, books, supplies, and equipment, it can be difficult to manage on top of their other various financial responsibilities. Despite the hardship that can come from education costs, the Internal Revenue Service offers tax breaks, such as credits and deductions, for qualifying students to help them pay tuition.

Tax Deductions Vs. Tax Credits

Tax credits and tax deductions can be used to lower how much a taxpayer owes in taxes for a given year, but their method of reducing their tax bill is different.

Tax deductions allow you to lower your taxable income by the amount designated in your tax bracket which can lower your overall tax bill. A standard tax deduction reduces your taxable income by a fixed amount, whereas an itemized deduction reduces your taxable income by varying amounts, depending on what tax-deductible items are written off.

Tax credits reduce your tax bill directly by providing a specific dollar reduction. While there are some non-refundable tax credits, if a tax credit is refundable, it can result in the taxpayer receiving a tax refund.

What is Modified Adjusted Gross Income?

Many tax credit eligibility requirements consider your modified adjusted gross income. MAGI is a taxpayer’s adjusted gross income in addition to some exempted items such as income or deductions. This figure is often close to or even identical to the taxpayer’s adjusted gross income, but in general, MAGI depends on the type of deductions.

  • Gross Income: Gross income includes all money earned across all sources, including wages, tips, bonuses, investment income, rents, or pension.

  • Adjusted Gross Income (AGI): AGI is the same as your gross income minus certain allowable deductions. This does not include itemized or standard deductions or any exemptions.

What is the American Opportunity Tax Credit?

In 2015, the Protecting Americans from Tax Hikes (PATH) Act was instilled and made the American Opportunity Tax Credit (AOTC) permanent. The American Opportunity Tax Credit is a type of education tax credit that qualifying students can utilize to pay toward qualified education expenses during the first 4 years of being enrolled in higher education.

The maximum credit a qualifying student may receive each year is $2,500, which can be extremely helpful for those who are struggling to manage their college expenses. Additionally, if this $2,500 education credit brings the total amount of tax the student owes to $0, they are eligible to have 40% of the remaining credit refunded to you up to a sum of $1,000.

The American Opportunity Tax Credit allows $2,500 per student because it offers credit for 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000 of qualified education expenses.

Which students are eligible for AOTC?

Eligibility requirements for students to receive the American Opportunity Credit depend on several factors. Qualifying students must:

  • Be actively pursuing a higher education degree or some other recognized educational credential

  • Be enrolled in classes for half time or more in at least one academic period during the tax year. An academic period could include a semester, trimester, quarter, or any other period of study structured by your academic institution.

  • Not have completed four full years of higher education at the time of the beginning of the tax year

  • Not have already accepted the American Opportunity Credit or the former Hope credit for four tax years or more.

  • Not have received a felony drug conviction by the end of the same year

Students who wish to apply for the AOTC must receive IRS Form 1098-T Tuition Statement from their eligible educational institution. This form is usually dispersed to students by January 31 of the current tax year and can help students calculate their estimated education tax credits. When you receive Form 1098-T, it is important that you read through the entire form to ensure everything is correct, and if it is, you can submit the form with IRS Form 8863 when you file your tax return to claim the American Opportunity credit.

Risks of Claiming the American Opportunity Credit

While it may seem tempting to accept any education tax credits you may be offered to help manage your expenses, it is important that you make sure that you are qualified before you claim the American Opportunity Tax Credit. If the IRS issues a tax audit on your tax return and you do not have sufficient documentation to prove your eligibility for the education credit, you will be required to pay back the amount you accepted from the AOTC in error along with the associated interest. Additionally, the IRS may insert a penalty or fine for inaccuracy or fraud. Alternatively, the IRS may ban you from qualifying for the AOTC for the next two to ten years.

Nevertheless, when you are gathering financial documents to determine if you qualify for the American Opportunity Credit and how much of the credit you are eligible for, as long as you keep organized records of your financial documents, you should be able to prove to the IRS that you do qualify for the credit.

Income Limits for AOTC

Similar to other forms of tax credits, there are certain income requirements that students must fall within to be considered for this type of tuition tax break. This income limit is evaluated based on your modified adjusted gross income (MAGI).

If an individual student who files their tax return as a single taxpayer has a modified adjusted gross income of less than $80,000 a year, they may be eligible to claim the full tax credit. If married taxpayers file jointly earning less than $160,000 a year through their MAGI, they may also qualify to receive the full credit.

Students who file their tax returns as single taxpayers whose MAGI falls between $80,000 and $90,000 may be eligible for a reduced amount of the AOTC. Taxpayers who are married filing jointly and whose MAGI is between $160,000 and $180,000 may also receive the partial credit.

If the MAGI for a single taxpayer is more than $90,000 or for married filers is more than $180,000, they will not be considered eligible for the AOTC.

What is the Lifetime Learning Credit?

The Lifetime Learning Credit (LLC) is another form of education tax credit that can help students manage their college costs. The LLC can be applied toward eligible educational expenses and college tuition for students enrolled in a qualified educational institution.

There are several types of degree courses the Lifetime Learning Credit can be utilized for, including undergraduate classes, graduate classes, and other professional degree courses that may help a person acquire new skills they can apply to their job in the workforce.

The Lifetime Learning Credit is worth 20% of the first $10,000 of qualified education expenses up to a limit of $2,000. The LLC can be claimed for up to $2,000 for every tax return, and there is no limit to the number of years you can claim this credit. It is important to note that, unlike the AOTC, the LLC is nonrefundable. This means that while you can apply the full $2,000 allowance toward any tax you owe, you will not receive any of that amount back as a tax refund.

Which students are eligible for LLC?

The requirements for a student to be eligible for the Lifetime Learning Credit are as follows:

  • Students must be currently enrolled in an eligible educational institution or taking higher-level courses.

  • Students must be enrolled in these higher-education courses as they work towards a degree, another recognized education credential, or to develop job skills.

  • Students must be enrolled in courses for at least one academic period during the beginning of the current tax year. Academic periods could include semesters, trimesters, quarters, or another period of study structured by their academic institution.

If a student determines that they are eligible for the LLC to help them pay their higher education expenses and course materials, they can claim the credit by filing Form 1098-T Tuition Statement from the eligible educational institution in which they are enrolled. Students must check that the information listed on this form is correct before claiming the LLC. Students typically receive Form 1098-T from their institution by January 31 of that same tax year, but if they do not receive the form, they can contact their school to rectify the issue.

If you are a student who wants to claim the Lifetime Learning Credit, you must meet all of the following requirements:

  • You, a third party, or your dependent, paid all of the qualified education expenses for the higher education.

  • You, a third party, or your dependent, paid the education expenses for a student who is enrolled at an eligible educational institution.

  • You, your spouse, or your dependent that is listed on your tax return is the eligible student.

Tuition and Fees Deduction

Tuition and fees deduction allows students to deduct up to $4,000 from their income to apply toward qualifying expenses for an eligible institution. The qualifying expenses include tuition and fees for students expanding their education above the high school level. Items that do not qualify for this deduction include housing, health insurance, transportation, or school supplies.

Student Loan Interest Deduction

When students are looking through their financial aid options to help them manage their college expenses, student loans are one of the most common approaches. Although student loans are effective in helping people make sizeable payments to financial institutions that they otherwise would not be able to afford, there are certainly downsides to this form of tuition help.

If you take out a student loan to help you pay for your college costs, you are required to pay back the money you borrowed along with the interest on that loan. It can take years for many students to fully pay back their loans, and by the time they have made their final payments, the interest accrued can be significant.

Student loan interest deduction allows you to deduct the lesser of either $2,500 or the amount you actually paid in student loan interest. When you are filing your tax return, this deduction can be claimed as an adjustment to your income rather than as an itemized deduction.

Eligibility Requirements for Student Loan Interest Deduction

A student must meet all of the following requirements to claim a student loan interest deduction:

  • The student paid interest on a qualifying student loan during that tax year

  • The student was legally obligated to pay interest on their student loan

  • Their filing status is not married filing separately

  • Their MAGI is less than the annually determined amount

  • Neither the student nor their spouse who files jointly can be claimed as a dependent on someone else’s tax return

If you are a student who struggles to afford their living expenses alongside their tuition, exploring education credit and deduction options can be significantly helpful in reducing your tax liability and managing your education expenses. Education tax credits such as the American Opportunity Tax Credit and the Lifelong Learning Credit can save eligible students thousands of dollars in school expenses.

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