The tax code can be marvelously complicated, but you should not let that deter you from taking advantage of tax-saving opportunities that may be available to you. Here we will lay out the basics of many tax breaks that may apply to your situation.
American Opportunity Credit
The American Opportunity Credit has been extended until 2017. This credit offers a maximum benefit of $2,500 per student for the first four years of postsecondary education, and up to $1,000 of the unused amount is refundable. Qualified expenses for the American Opportunity Credit include tuition, fees, supplies, and books. To be eligible, a student must be attending with at least half-enrollment.
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Lifetime Learning Credit
The Lifetime Learning Credit offers a maximum credit amount of $2,000 per year but may be used in any year, not limited to just the first four years. There is not a minimum enrollment to be eligible, and the student does not have to be earning a degree. Unlike the American Opportunity Credit, the Lifetime Learning Credit is non-refundable. It is important to note that this credit is a per-return amount and not dependent on the number of students.
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Tuition and Fees Deduction
The Tuition and Fees Deduction can be taken for up to $4,000 of qualified expenses. This is an “above-the-line deduction” which is available whether you itemize or take the standard deduction. This deduction expired at the end of 2013, but work has begun to revive these provisions and extend them through 2015. This deduction cannot work in conjunction with education credits, so you must choose one or the other for each student based on which provides the largest benefit.
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Student Loan Interest Deduction
You may be able to deduct the interest paid on a loan for qualified higher education expenses. This deduction is also considered an above-the-line deduction available to taxpayers who do not itemize deductions. The Student Loan Interest Deduction is available for the lesser of $2,500 or amount of interest paid.
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The IRS allows certain savings plans to provide tax benefits when proceeds are used for qualified education expenses. Contribution to a 529 plan, or QTP (qualified tuition plan), are not deductible; however, the principal and earnings are allowed to grow tax free if they are used for qualified education expenses. There are no income limits or limitations on the amount that can be contributed.
The Coverdell Education Savings Account is another savings plan available. Contributions to this plan are not deductible, and the distributions and growth are tax free if used towards qualified education expenses. This plan can be used for K-12th grade as well as graduate level education. There are contribution limits of $2,000 per year as well as income limitations for this plan.
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If distributions are made from an IRA account before the age of 59 1/2, the 10% early withdrawal penalty may be waived if used for qualified education expenses. This option does subject the distributions to income taxatoin, and is likely the least favorable method of funding education from an income tax perspective.
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These are simple summaries of tax savings opportunities. Every taxpayer’s situation is unique, and there may be further restrictions.