ABC's of Education Tax Benefits

Tax Code complexity has come up in a number of conversations this week, so that inspired the concept of a topic related to demystifying important yet unclear areas of the code.  This creates plenty of choices as, according to the IRS official count, the IRC  has 3.8 million words.  Tax credits for education caught my eye first. According to Saturday’s piece in the Wall Street Journal , IRS wordsmiths explain these benefits in an 84 page booklet.  I’ll try to stick with highlights.

The winner of all the tax benefits is the American Opportunity Tax Credit.  This covers up to $2,500 a year in qualified education expenses up to$2,500.  Anyone who goes to college more than half time is eligible (assuming you meet the AGI cutoffs < $90,000 for singles and < $180,000 for married filing jointly).  The best part about this credit is that up to 40% of it is refundable.  So if you don’t owe enough tax to get the credit as a reduction in taxes, Uncle Sam cuts you a check.  This benefit is set to expire in 2012 – so don’t budget for it past that year.  It’s been extended before, but you never know. Oops – one more exclusion – you can’t deduct education expenses the same year you get the credit.

 If graduate school or some other continuing education is what’s causing your tuition pain, then the Lifetime Learning Credit is your best shot.  While it’s available for undergraduate expenses, you can’t use it at the same time you get the AOTC, and it’s for a maximum of $2,000. The AGI cut offs are lower for this one (< $61,000 single, and <$122,000 for married filing jointly).  You also can’t take this credit if you’re taking a deduction.

Speaking of taking a tuition deduction -- you can do this if you are going to school for a line of work you’re already pursuing.  It’s up to $4,000 for AGI < $65,000 single, or < $130,000 married filing jointly.  This benefit expires after the 2011 tax year, so barring congressional action, this is the last year you can deduct tuition.  You will be able to continue deducting the interest on your student loans through 2012. 

If your employer is helping to pay your tuition, up to $5,250 can be excluded from your income, and there’s not AGI cap to worry about.  One other tax benefit that’s not subject to income thresholds is raiding your IRA for tuition help.  No early withdrawal penalties kick in, but you will have to pay tax on that money once it comes out. 

Finally a quick mention for tuition savings plans.  Coverdell Educational Savings Accounts allow you to put away $2,000 a year, and take out the proceeds to pay for education without paying taxes on any growth that occurs in the interim.  The proceeds must pay for education for someone under 30 years old, and there are AGI restrictions for these accounts.  529 plans are state specific, have no AGI limitations, and can be used to pay for anyone’s educational expenses.