By Amy Feldman
NEW YORK, March 12 If you have kids in college,
you already know that higher education isn't getting any cheaper
- some private schools will now set you back more than $60,000 a
You may need a high-priced education just to figure out how
to write it off. The federal government offers a variety of tax
breaks to lessen your burden. But they are complicated, limited
and overlapping, and it is not always easy to figure out how to
And if you've already saved money in a tax-favored 529
college savings plan, that adds another layer of complexity to
your tax calculations.
Here's a brief guide for the perplexed.
THREE BIG BREAKS
There are three main educational tax breaks to consider at
tax time. First, the American Opportunity Tax Credit, which
offers a $2,500 tax credit per student. It is the best of the
Second, the Lifetime Learning Credit, a less-valuable
credit, allows you to reduce your taxes by up to $2,000 per
Finally, the tuition and fees deduction lets you deduct up
to $4,000 from your taxable income. Remember that a deduction,
which reduces the income subject to taxes, is worth less than a
credit, which lowers your tax bill dollar for dollar.
Of course, there is a catch: You have to choose which credit
or deduction to take, and there's no double-dipping.
If you have one child in college, you must pick one. A
family with two kids in college may be able to mix and match but
can take only one credit per student. In the case of the
Lifetime Learning credit, the maximum credit is $2,000 per
return, regardless of how many students your family may have in
Making matters more complicated, all three tax breaks have
different income limits and eligibility requirements on the
kinds of educational costs they will cover. (For all the
nitty-gritty details, see the Internal Revenue Service's
publication 970, Tax Benefits for Education.)
FORMULATING A PLAN OF ATTACK
Since you cannot take more than one of these tax breaks per
student, you need to prioritize. If you qualify for all of them,
take them in this order: First, the American Opportunity credit;
then the Lifetime Learning credit; and finally the tuition and
In the 28 percent tax bracket, for example, both the $2,000
and $2,500 credits will trump the $4,000 deduction, which would
lower your federal tax bill by just $1,120.
The American Opportunity credit has advantages for both
upper-income taxpayers and lower-income ones. It has the highest
income cap of the three, partially phasing out at $160,000 in
income for married couples filing jointly and disappearing
completely above $180,000.
At the low end, the credit is especially valuable because it
is partially "refundable," as it's known in tax lingo, meaning
you can claim a piece of it even if you don't owe any tax.
That's unusual; most credits can only be used to lower the tax
The caveat is that the American Opportunity credit is for
undergraduate education only, and you can claim it only four
years per student.
The Lifetime Learning credit, on the other hand, can be used
for all post-secondary education, including courses you take to
improve your job performance. A student in graduate school, for
example, would qualify for the Lifetime Learning credit but not
the American Opportunity credit; so, too, would someone taking a
few college courses but not pursuing a degree. Since you can
take it for an unlimited number of years, you also could claim
it for a student who's already maxed out the American
For tax purposes, those paying for higher education will
receive a Form 1098-T from the college or university. Check it
over closely; some recipients have found errors on their forms
that can bring unwanted attention from the IRS.
WHO TAKES THE CREDIT?
Because of the income limitations, many upper-income parents
may not qualify for the education credits, though their children
might. That can be a great strategy.
"I just finished somebody's return, and it saved them $800
to take the education credit on the child's return," says Bill
Fleming, managing director in PwC's personal financial services
division. "The kid had made money in the summertime, so was
going to pay some income taxes."
The general rule is that if the parents claim their kids as
dependents, only they can claim a college credit. For the
student to claim the credit, he or she cannot be claimed as a
dependent on the parents' tax return. That can be worthwhile if,
as in Fleming's clients' case, the parents make so much that
they would lose tax breaks for their kids anyway under
alternative minimum tax rules.
It's a case-by-case determination, Fleming says, and you
need to run the numbers. Then you need to remember from year to
year which children are on the parents' tax returns.
"We are constantly doing these back-and-forth calculations,"
WEAVING IN THE 529 PLAN
If you've saved in a 529 college savings plan or a Coverdell
education savings account, congratulations - the funds you
withdraw for tuition and fees won't be taxed. But that will add
another layer of complexity to your tax return.
You can't get double tax breaks for the same educational
expense, so if any part of it was already covered by tax-free
scholarships, Pell grants or these tax credits, using money from
a 529 plan to cover the same expenses may trigger a tax on that
Let's say you have one child in college and incur qualified
educational expenses of $21,000. If you got $12,000 in tax-free
assistance (from scholarships, fellowships or Pell grants),
you'd have $9,000 in remaining educational expenses. You could
then claim the American opportunity credit. It works on a
formula in which you get to claim 100 percent of the first
$2,000 in expenses, but only 25 percent of the next $2,000, for
a total of $2,500 in credits for $4,000 in expenses.
How much could you withdraw tax-free from your 529 plan?
Subtract the eligible expenses from that $9,000 to get the
answer: $5,000. If you go above that amount, you'd owe tax on
the earnings, but not the principal, of that withdrawal.
So plan your withdrawals accordingly, and then give yourself
a back pat: If you can work your way through all that financing,
you deserve some sort of honorary degree, at least.
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