By Mark Hodges, CPA, Tax Supervisor | Family, Executive & Entrepreneur Advisory Services Team
Paying for College? Overview of Tax Credits, Deductions, and 529 Plans
Now that we are approaching the college acceptance season, let’s catch up on a few education related tax items that may reduce overall tax liability next April.
There are two education credits available to offset federal tax liability, both of which are subject to income phase-out limits. For married filing joint taxpayers, the credit begins to phase out at $160,000 and is completely phased out at $180,000 (for single filers these amounts are $80,000 and $90,000 respectively). Taxpayers filing as married filing separate are not eligible for either credit.
American Opportunity Tax Credit (AOTC)
- Eligible students must be enrolled at least half-time in a post-secondary degree program.
- The credit is generally $2,500 if there are qualifying expenses of at least $4,000. The amount of the credit is based on 100% of the first $2,000 of expenses plus 25% of the next $2,000.
- The AOTC is only available for the first four years of post-secondary education (undergraduate).
- 40% of the AOTC may be refundable, after applying the phase-out limits above.
- The AOTC is a per-student credit. If there are multiple students that meet the requirements, taxpayers may claim the AOTC for each student.
Lifetime Learning Tax Credit (LLTC)
- Eligible students must be enrolled in one or more courses that are part of a degree program. Eligible courses also include those that improve job skills if they are not part of a degree program.
- The credit is generally $2,000 if there are qualifying expenses of at least $10,000. The amount of the credit is based on 20% of up to $10,000 of aggregate expenses paid for an eligible student.
- There is no limit on the number of years a taxpayer may claim the LLTC.
- The LLTC is limited to the taxpayer’s federal liability.
- The LLTC is a per-taxpayer credit. Only one LLTC may be claimed on each tax return.
*If eligible students receive a qualified scholarship or employer provided educational assistance, taxpayers must reduce the qualifying tuition and expenses to calculate the credit by the amounts received that are not includable in gross income. In other words, the amount of tuition claimed for the credit is generally limited to amounts paid out-of-pocket.
Education Credit Tax Planning Opportunity
Often a parent’s adjusted gross income is too high to receive any benefit from education credits related to tuition paid for a dependent. In this case, parents can forgo claiming the dependent on their return and let the child claim the education credits on their tax return. The child can claim either the AOTC credit or the LLTC credit, however neither is a refundable credit when claimed on the dependent’s tax return. As such, this strategy is only beneficial when the child’s tax return generates a tax liability to claim the credit against.
Tuition Deduction Update
As a result of the Taxpayer Certainty and Disaster Tax Relief Act of 2019, the deduction available for tuition and fees expired on December 31, 2020.
Virginia 529 Plans
After the enactment of the 2017 Tax Cuts and Jobs Act, 529 plan funds may be used for K-12 education expenses in addition to college education expenses. Taxpayers may claim a Virginia deduction of $4,000 per account, per taxpayer on their state tax return. If contributions exceed annual limits, the excess deduction is carried forward indefinitely and deducted annually each year thereafter. If the taxpayers are over the age of 70, these taxpayers may claim a Virginia deduction equal to the full 529 contribution each year. When funds are used for educational expenses, withdrawals from the plan are tax free at both the Federal and state levels. Note that each student may use up to $10,000 annually for qualifying K-12 educational expenses. There are no limits to withdrawals for post-secondary educational expenses. Learn more about 529 account strategies.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.