12 Ways to Use Taxes to Make College Cheaper
Editors' pick: Originally published July 15.
"If only someone would make this just a little bit easier."
It's a thought that's struck everyone who pays college tuition at least once in a while. Whether you're footing the bill or shoveling hundreds of dollars out the door every month in student loans, it would be great to get a bit of a break.
Well, good news. Your least favorite government agency is up to the task. The tax code has several exceptions that reward higher education in the form of tax breaks, credits and even outright refunds.
Want to get a few (or even a few thousand) bucks back next April? Paying for someone's education, or even your own? Then read on to find out how it all works.
This is probably the best of them all. The American Opportunity credit allows up to $2,500 per eligible student, calculated based on a combination of income and expenses. It's a credit, which means that you get a dollar-for-dollar reduction of liability. Even better, $1,000 of this credit is refundable, which means that you can actually reduce your tax burden below zero and get some straight-up free money from the government.
This only applies to the first four years of undergraduate education, and only for students attending school at least half-time (so no signing up for an extension course to pay for that trip to the Bahamas).
Still, $2,500 per student? That's not a bad bit of change, even it's a tiny fraction of what you'll actually spend on tuition.
Graduate from college and lose $500, but there's still credit available after college. The Lifetime Learning credit is worth up to $2,000 per eligible current student and applies to all post-collegiate education. Whether it's a Ph.D. or just polishing some job skills, this helps make the tuition sting a little less.
Unfortunately, it's not refundable. Unlike the American Opportunity credit, the best this can do is reduce your tax burden to zero. Of course, that's not a bad problem to have.
Like the American Opportunity credit this is calculated based on a combination of income and qualifying expenses, so the more you spend on school, the more you'll get back from the government. So, law students, take heart! There's a little bit of light before the world starts turning the screws.
Deductions aren't as much fun as tax credits, but this is one of the best you can claim.
A tax deduction reduces your taxable income before any liability is calculated, so someone making $50,000 with $5,000 in deductions will pay as though they'd made only $45,000. To be frank, most tax deductions are of little value to the average taxpayer. Few people will itemize their taxes, choosing instead to take the standard deduction as it's more valuable; however, tuition and fees are an exception to the rule. This tax break is available whether or not you file a line-item return and can reduce your taxed income by up to $4,000.
The catch? Well, there are two... First, this only applies to qualifying expenses (we'll get into that later). The second, taxpayers can't take this at the same time as a credit, so it's mainly for those whose income disqualifies them from the American Opportunity or Lifetime Learning credits.
There's nothing fun about student loans. They're a youth tax, one levied by Baby Boomers, who once upon a time paid tuition with a summer job... then quintupled the price of college as soon as they got in charge.
Still, for those who regularly sign over their paychecks to the Department of Education there's a little bit of relief! You can take a tax deduction for up to $2,500 each year based on how much interest you pay on those student loans.
Admittedly. it's grim to consider paying $2,500 per year in interest alone, and this is only a tax deduction, but it's certainly better than nothing.
Those are, in a nutshell, the big four programs for taking advantage of your taxes to help out with higher education.
Doing that takes some forethought, though.
"These tax breaks aren't going to pay off your college degree, the numbers aren't that big, but it's better than nothing," said Larry Pon, an accountant with Larry Pon CPA and spokesman for the California Society of CPAs. "But part of it comes with panning and strategizing."
There are a lot of wrinkles to work through when it comes to making the most of your taxes, in any field. One issue here? Don't forget that your spouse can qualify for these tax breaks. Too many people think of students as traditional teenagers and early-20-somethings, but adult education isn't disqualified. So if your wife has decided to go back and get that masters, make sure to go out and get that deduction.
A family can claim their adult children as dependents up until age 24, as long as they remain in school. That might be the default, especially for students who have negligible income during the year, but as Edward, Ellis, Armstrong & Company CPA Jeffrey Miller pointed out, it's not always the right call.
"The credits and deductions attach to where the dependency exemption is," Miller said. As a result, whoever claims the individual on their taxes (whether it's parents claiming a dependent or students filing for themselves) gets to file for the tax break.
What if, Miller pointed out, the parents make too much money to qualify for one of the tax credits? Particularly in the case of the American Opportunity credit's refundable $1,000, there might be some real value for broke students who want to claim themselves and capture some of that money. Of course, it will cost the parents some money in losing a significant exemption.
Here's the thing about all those lovely tax breaks, they all apply only to qualifying educational expenses.
It's not just the deduction either. The American Opportunity and Lifetime Learning credits aren't flat grants; they give a portion of that money calculated (in part) based on how much you spent on things that count at a qualifying institution.
"In the past the credits were calculated on a very narrow definition of what is educational expenses," Miller said, "but now that it's been re-figured they allow you to include calculations for room and board, a laptop, sometimes an internet connection, as long as you attend a qualifying educational institution and the expenses are related to that."
"They credits have," Pon agreed, "become, to me, a little simpler, a little less complicated."
So, students, pay some attention. The government counts a lot into the life of the student, but they'll probably draw the line at that killer gaming rig.
"One thing about tax planning," Pon said. "I'm in the San Francisco area and I'm seeing these internships at Salesforce.com, Twitter, the big names like Facebook and Google. For the summer a student might make 30-grand. We'll tell the parents, for this year you're not going to claim the kid as a dependent. He'll claim himself and that lets him take the credit."
As discussed earlier, sometimes it's better to allow a student to claim his own taxes for the sake of these credits, but it's also important to remember that income matters for all of these deductions and credits.
Every single tax break in this article phases out above a certain income threshold. Household income is part of the calculation of how much the American Opportunity and Lifetime Learning credits give back, and above $80,000 single/$160,000 joint even the educational expenses deduction phases out.
The student loan system was effectively designed by a Disney villain. In addition to being un-dischargeable in bankruptcy, with federal limits set well below rates of tuition, what little forgiveness there is comes with a hefty price tag: it is often taxed as income.
Here's how it works. In some cases, the federal government will forgive, or "discharge," your loans after a qualifying period of time. For those who work in public service that's 10 years (technically 120 payments), while for those who pay on an income-based scheme that's generally 20 years.
The catch is that the IRS considers a discharged debt of any kind to be income (subject to some exceptions). So for many graduates, particularly those who used income-based payment because they earn too little, when the rest of your loan vanishes the tax man will show up with a hefty bill. (https://studentloanhero.com/featured/owe-taxes-student-loan-forgiveness/) (Graduates who take public interest forgiveness are exempt from this.)
And it's going to be due all at once.
Before you take off for foreign shores better make sure that Caribbean campus is kosher with the Department of Education, otherwise you can't claim a single one of these line-item benefits.
You see, as Miller pointed out, to claim a qualifying tax credit or deduction you must have eligible expenses at a qualifying educational institution. Who counts? Per the IRS.:
An eligible educational institution is a school offering higher education beyond high school. It is any college, university, vocational school or other post secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education.
To their credit, the government does recognize some overseas schools. Just be sure to check before you count on that $2,500 credit to cover the airfare to Mumbai.
Many employers have begun to experiment with a bold way to attract Millennials: offer to pay off their debt.
It's a great benefit, although sadly not without the standard catch: the IRS considers it income.
Much like any other employer benefit, for example health insurance, this will be calculated into your withholding. Happily, it's not something you have to think about, and you'll certainly pay less in taxes than you would in loans.
A 529 plan, Miller explained, "is like an educational IRA." You can invest money and, as long as it's spent on qualifying expenses at an eligible institution, withdraw principal and proceeds tax free.
While some states have local programs with different contours, the IRS doesn't exempt the initial investment from taxable income. Still... the ability to roll that money over year after year without taxes will come in very handy when the kids grow up.