Turn Class Credits Into Tax Credits

This April, I'm dodging the tax man.

Hold on. Before you alert the authorities and have me sent to Sing Sing for tax evasion, hear me out.

Last year, I was a student and a free-lancer writer, making me eligible for education credits and education-related business deductions.

For many students these tax breaks can significantly reduce students' tax bills.

In my case, I meet the criteria in every way, leaving me with a tax burden of zero, zilch, nada.

That's the good news. The bad news is that my tax-free year required me to go tens of thousands of dollars into student-loan debt.

I had long assumed there'd be a tax benefit to getting student loans -- that I'd get some mythical deduction -- in much the same way I had assumed people who own homes get to write off a lot of their expenses and complain about the Alternative Minimum Tax.

No such luck.

It turns out, if, after graduation, you find yourself searching on Craigslist for night admin work to make ends meet, you're almost certain to be taking the standard deduction. The $2,500 you could deduct for interest payments on your student loans if you were itemizing your taxes (and earn less than $70,000) isn't going to save you a penny.

Thankfully, student loan interest isn't the only educational tax break.

Combining my freelance pay and scholarship stipend, I cobbled together a taxable income of $12,625 last year. (It's not as bad as it sounds -- student loans and my parents' generosity also covered some of my personal expenses.)

Taking the standard deduction, I would owe about $728 in federal taxes and $402 in self-employment taxes.

But I was in luck because two education credits, Lifetime Learning and Hope, can significantly reduce students' tax bills.

I qualified for the lifetime learning credit because I met these three criteria:

• Be an eligible student -- an eligible student being "a student who is enrolled in one or more courses" (I was enrolled in nine courses over the year).

• Be enrolled at an eligible educational institution -- defined as any postsecondary educational institution "eligible to participate in a student aid program administered by the Department of Education." (I've got more than $20,000 of student loans to prove it.)

• Earn less than $47,000 per year. (I earned $12,625 in taxable income.)

Select taxpayers who don't meet the above criteria may also qualify, and a subset of people who qualify for the Lifetime credit may qualify for and be better off with the Hope credit.

As with anything related to the Kafkaesque U.S. tax system, there are other limitations for both credits.

But if you do qualify for the full Lifetime Learning credit (and, like me, most people who meet the above three qualifications will) you'll be able to reduce from your tax bill 20% of the first $10,000 of your tuition and fees. (This is a credit, not a deduction, first you calculate taxes owed and then you reduce by the amount of the deduction.)

That's right, I get a tax credit of $2,000. (A cool 10Gs barely gets you in the door at New York University, and a great many other colleges.)

But I don't owe anywhere near $2,000 in federal taxes. Unfortunately, tax credits can only drive a tax bill to zero. I won't be getting any extra money back.

So, effectively, after the first $3,640 of educational expenses, I stopped getting any tax relief.

Perhaps I'm getting greedy, but a federal tax bill of zero isn't an overall tax bill of zero. I owe self-employment taxes (Social Security and Medicare) on the $2,625 I earned writing freelance articles.

But, it turns out, the IRS says that I may "deduct the cost of my own education ... related to [my] trade or business." I can't deduct the education expenses I used for the Lifetime Learning credit, but I've got plenty of leftover expenses to go around. And a master's in journalism, by my judgment, is a necessary and ordinary expense for a free-lance journalism business.