When it comes to education, most financial planning focuses on ways to save and invest for college. This makes sense because in an ideal world we would all be able to cover all of our education costs this way without needing to take out a loan. But in the real world, this rarely happens. Fortunately, there are parts of the tax code that can help relieve this burden if you know how to use them. Let’s take a look at some of these tax breaks and how you can qualify for them.
Business deduction for work-related education
If you recently went back to school to qualify for your current job, this can be the most beneficial tax break since you can potentially deduct the entire cost of tuition, required books, and other materials from your taxable income. If these expenses add up to $30,000 and you’re in the 24% tax bracket, that saves you $7,200 in taxes. That’s like getting 24% off the cost of your education!
As you might have suspected, there is a catch. Actually, there are several. First, this deduction is difficult to qualify for. The first way to qualify is if the education is required by your employer or by law to maintain your current status, salary or job, and it must serve a bona fide business purpose of your employer. Another way to qualify is if the education maintains or improves skills in the job you had before starting the program.
However, in neither case can you be required to meet the minimum educational standards of your profession. This means that your law or medical degree will not qualify if you are a lawyer or doctor. Also, if it qualifies you for a new profession or occupation, that doesn’t count either. If you’re a manager and went to business school to improve your management skills, you might be eligible, but if you worked in accounting and went to business school to move into management, you’re out of luck.
As you can see, you really need to thread this needle. Your best bet is to get a letter from your employer stating that your education meets any of the requirements and does not violate anything that would disqualify you. You may also want to consult with a tax professional, as taking large deductions that you don’t qualify for could mean a much larger penalty.
Finally, if you manage to jump through all the hoops, it’s an itemized deduction that can only be deducted from your income to the extent that it (plus other work expenses and other miscellaneous deductions) exceeds 2% of your adjusted gross income (AGI). For example, if your AGI is $100k, you can only deduct expenses for the first 2% of $100k, or $2k. Given the size of today’s tuition fees, this shouldn’t be too much of a problem for many.
The American Opportunity Credit
Since this is a credit, you can deduct up to $2,500 (100% of the first $2k of eligible expenses and 25% of the next $2k) per student (you, your spouse or dependent) for up to 4 years of undergraduate tuition and required fees and materials, including books. However, the amount of the credit begins to phase out once your modified AGI passes $80K or $160K for a joint return. On the other hand, 40% of it goes back to people who don’t earn enough to pay income tax.
Lifetime Learning Credit
This credit is similar to the American Opportunity Credit, but it’s a little smaller – up to $2,000 – and this amount also begins to phase out when MAGI exceeds $80k or $160k for a couple. It is also non-refundable. However, it is more flexible as it is not limited to undergraduate education and can therefore be applied to graduate programs or just a few courses. However, both credits cannot be taken in the same year for the same student.
No double dipping
It’s important to note that you can’t use any of these tax credits for expenses that are already covered by other tax credits, a tax-free account like a 529 plan or a Coverdell account, or other forms of tax. Free educational aid, such as Pell Grants and veterans programs. In other words, no double dipping is allowed. (This limitation does not apply to funding sources that are generally tax-free, such as loans or inheritances and gifts.) There are withdrawals from 529 and Coverdell accounts of no more than the amount of qualified expenses that are not covered by one. Of these tax benefits.
Student loan interest deduction
Tax credits don’t necessarily stop with tuition fees. If you’re not a dependent on someone else’s tax return and you’re within the MAGI limits, you can deduct up to $2,500 a year in interest on student loans you’re legally obligated to pay. That last part means you can’t deduct the interest on loans in your children’s names, even if you make the payments.
Education is expensive and costs are rising faster than inflation. The good news is that we can offset this cost by cutting taxes. The bad news is that these breaks can be complicated, so unless you have a good tax preparer, it will take some time to understand them, and that can be an education in itself. Why is there no special tax break for this?