Student Loan Tax Deductions & Education Credits

    Paperwork for Student Loan Tax DeductionsAmid all the cautionary advice to students about not borrowing too much to pay for college, one bit of good news can go unnoticed: Interest paid on student loans is tax deductible and a significant amount of the tuition and fees paid while pursuing a degree can be offset with tax credits.

    Student loans make college more affordable but can lead to mountainous debt that takes many years to repay. These loans, which can’t even be discharged in bankruptcy court, are millstones for the Millennial generation, many of whom find themselves drowning in debt as they start their adult life.

    Tax credits and tax deductions can be lifesavers.

    The deductions lower your taxable income and are called the Student Loan Interest Deduction and the Tuition and Fees Deduction.

    Two other savings are tax credits, which reduce the amount of taxes paid. They are the American Opportunity Tax Credit and the Lifetime Learning Credit.

    The Internal Revenue Service (IRS) sets guidelines for using these deductions and credits, and they come with complexities. If you think you qualify, consult the IRS or a tax preparer to learn how they fit your situation.

    Student Loan Interest Deduction

    Borrowers can use the Student Loan Interest Deduction to reduce their taxable income as much as $2,500 as long as your adjustable gross income falls below specified limits.

    The Student Loan Interest Deduction is what tax accountants call an “above the line” deduction, meaning you can claim it even if you don’t itemize other deductions.

    The student who took the loan must be you, your spouse or your dependent for you to take the deduction. The money borrowed must be a commercial student loan used exclusively for education-related expenses and the borrower needs to be enrolled at least half-time to qualify.

    Loans from another family member, certain corporations and organizations or those made under a qualified employer plan, are not eligible.

    A taxpayer, spouse or dependent can take the deduction as long as the person is legally responsible for repaying the loan and cannot be claimed as an exemption on another’s tax return. Until the loan is paid off, all interest paid during the tax year can be deducted up to the statutory limit. The deduction can be claimed even if the taxpayer does not itemize deductions.

    Qualified expenses paid for with the loan money include:
    • Tuition and fees
    • Books, equipment and supplies
    • Room and board
    • Other necessary expenses including, for instance, transportation

    To be eligible, individual filers with modified adjusted gross income (MAGI) below $80,000 and couples filing jointly with incomes of less than $165,000. The deduction amount begins to phase out for individuals with MAGIs of more than $65,000 and couples with more than $165,000.

    Tuition and Fees Deduction

    The Tuition and Fees Deduction can reduce your taxable income by as much as $4,000. It is available to single filers whose modified adjusted gross income isn’t higher than $80,000 and married filers whose joint MAGI doesn’t exceed $160,000. The deduction applies only to tuition and fees at eligible post-secondary educational institutions, but can’t be applied to room and board.

    You are permitted to take the deduction for qualified expenses even if you paid for them with borrowed money. The deduction can also be taken if you paid student loan interest, and taking it still allows you to take the Student Loan Interest Deduction.

    Like the student loan deduction, Tuition and Fees is an above the line entry on your tax return, meaning it is available even if you don’t itemize deductions with tax schedules. And, like the student loan deduction, the amount you can deduct phases out between $65,000 and $80,000 for single filers and between $130,000 and $165,000 for married couples filing jointly.

    You cannot take the Tuition and Fees Deduction under certain circumstances, including:
    • If you are married and filing taxes separately
    • You are claimed as a dependent on someone else’s tax return
    • You claim either the Lifetime Learning or The American Opportunity tax credits in the same tax year
    • You are a non-resident alien during any part of the tax year and elect not to be treated as a resident alien
    • Expenses paid by tax-free scholarships or awards, or a tax-free withdrawal from a college savings plan or Education Savings Account (ESA), don’t qualify for the deduction.

    American Opportunity Tax Credit

    The American Opportunity Tax Credit (AOTC) isn’t easy to qualify for, but can make paying for college a good deal easier. The credit allows you to take as much as $2,500 off your taxes for each of four years in pursuit of a college degree.

    To qualify, a student must be enrolled in an eligible degree or certificate program at least half time and have no felony drug convictions. It applies exclusively to the first four years of college, so students who have finished four full years of schooling no long qualify.

    The AOTC offers a credit of 100% on the first $2,000 of qualifying educational expenses and 25% on the next $2,000, for a maximum of $2,500. It requires a completely separate form attached to a Form 1040 tax return and receipt of a Form 1098-T from the institution where the student was enrolled.

    The AOTC cannot be used for room and board, transportation, insurance, medical expenses or any fees unless they are required. In addition, the AOTC can’t be claimed in the same year as a Tuition and Fees Deduction, and a student is not allowed to take a Tuition and Fees Deduction if someone else claimed his or her AOTC on their return for the same tax year.

    Taxpayers are not required to file for the deduction in a particular tax year as long as they don’t exceed the four-year limit. So, if a student finishes high school and enrolls in college for the fall semester, the credit doesn’t have to be taken in that year.

    Students who are independent and not claimed as exemptions on their parents’ tax return can qualify for the AOTC. Otherwise, their parents can claim the credit. Forty percent of the credit for which you qualify, up to $1,000, is “refundable,” meaning that a filer can get money back even if no taxes are owed for the year.

    The full credit is available to individual filers with a MAGI of $80,000 or less and married joint filers with joint a MAGI of $160,000 or less. Partial credit is available for MAGIs of up to $90,000 for single filers and $189,000 for married couples filing jointly.

    Lifetime Learning Credit

    The Lifetime Learning Credit of as much as $2,000 per year is aimed at low- and middle-income filers who paid for post-secondary education but don’t qualify for a tax break under the American Opportunity Tax Credit strict requirements.

    The Lifetime Learning credit doesn’t require a student to be pursuing a degree or to be enrolled at least half time like the AOTC. It also eliminates the AOTC limitation to a credit only during the first four years in a degree or certificate program.

    To apply for the credit, filers must attach a Form 1098-T from the academic institution where the student studied and complete a tax form 8863 and attach it to the Form 1040 or 1040-A tax return.

    Lifetime Learning places no limit on the number of years a credit can be claimed. This makes the credit particularly helpful to graduate students, students who are attending school less than half-time and those taking classes to improve or acquire job skills and not necessarily to get a degree.

    Eligible expenses include tuition, fees and any books and equipment required by the school. The credit cannot be claimed for room and board or for any expenses that were paid for by a grant, scholarship, employer or education savings account.

    For single filers, the credit is phased out starting at $55,000, and not available to those with adjusted gross incomes of more than $65,000. For married couples filing jointly, the credit is available for MAGIs of $110,000 and is gradually phased out up to a maximum allowable MAGI of $130,000.

    The Lifetime Learning Credit cannot be used in the same year for the same student if either the American Opportunity Tax Credit or the Tuition and Fees Deduction is claimed

    The credit is worth up to 20% of the first $10,000 of qualified expenses, and one deduction is allowed for each tax return, so that if a parent has more than one student in college, only one Lifetime Learning credit can be taken.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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