First, a bit of non-news: College is expensive. Last school year, private colleges averaged over $31,000. But there is some relief available from a tax perspective.
This article will give you a brief, general overview of some tax relief available for dealing with education expenses. You can use it as a checklist to go over with your clients during your next sit-down with them.
But remember, the list is brief and general. For more information, and more specifics, you should refer to IRS Publication 970. This publication is generally updated annually at the beginning of the year. The most current version is from 2014. This is important because, as discussed below, in 2014 there was a deduction available for qualified tuition and fee expenses that is not available now.
1. Taxation of Scholarships, Fellowship Grants, Grants and Tuition Reductions: A scholarship or fellowship grant is tax free (excludable from gross income) only if the recipient is a candidate for a degree at an eligible educational institution. Fulbright grants, Pell grants and other Title IV need-based education grants, and benefits received from Veterans Affairs, are generally treated as a scholarship or fellowship grant. But payments that students at the military academies receive are not scholarships and are includable in income. Qualified tuition reductions are generally not includable in income.
2. American Opportunity Tax Credit: A taxpayer may be able to claim a credit in 2015 for up to $2,500 (depending upon the taxpayer’s income) for adjusted education expenses paid for each student who qualifies for the American Opportunity Tax Credit, or AOTC. Forty percent of this credit may be refundable (i.e., the taxpayer can receive money back even if he does not owe any income taxes). If a taxpayer elects to receive this credit, then he or she cannot also claim the lifetime learning credit (discussed below).
3. Lifetime Learning Credit: If taxpayers cannot claim the AOTC, they might be able to claim the lifetime learning credit. This is a credit of up to $2,000 for qualified education expenses paid for all eligible students. The credit is nonrefundable (unlike the AOTC).
4. Student Loan Interest Deduction: Generally, personal interest paid, other than certain mortgage interest, is not deductible. However, if a taxpayer’s modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return), there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of the taxpayer’s income subject to tax by up to $2,500 in 2015.
5. Student Loan Cancellations and Repayment Assistance: Generally, if a taxpayer is responsible for making loan payments, and the loan is cancelled (forgiven), the taxpayer must include the amount that was forgiven in gross income for tax purposes. However, if the taxpayer fulfills certain requirements, two types of student loan assistance may be tax free. The types of assistance are student loan cancellation and student loan repayment assistance.
6. Coverdell Education Savings Account (ESA): If a taxpayer meets the income requirements, he or she can contribute to a Coverdell ESA. Contributions are not deductible, but income in the account grows tax free until it is distributed; and distributions are tax free if the distributions are not more than a designated beneficiary’s qualified education expenses at an eligible educational institution.
7. Qualified Tuition Programs (QTPs or 529 Plans): Contributions are not deductible, but income in the plan grows tax free and no tax is due on a distribution unless the amount distributed is greater than the beneficiary’s adjusted qualified education expenses.
8. IRA Distributions Not Subject to Additional Tax: Generally, if taxpayers take a distribution from an IRA before reaching age 59½, they must pay a 10 percent additional tax on the early distribution. This applies to any IRA they own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA or a SIMPLE IRA. The additional tax on an early distribution from a SIMPLE IRA may be as high as 25 percent. See IRS Publication 560, Retirement Plans for Small Business, for information on SEP-IRAs, and IRS Publication 590-A and 590-B for information about all other IRAs. However, taxpayers can take distributions from their IRAs for qualified higher education expenses without having to pay the 10 percent additional tax. They may owe income tax on at least part of the amount distributed, but they may not have to pay the 10 percent additional tax. Generally, if the taxable part of the distribution is less than or equal to the adjusted qualified education expenses (AQEE), none of the distribution is subject to the additional tax. If the taxable part of the distribution is more than the AQEE, only the excess is subject to the additional tax.
9. Education Savings Bond Program: Generally, taxpayers must pay tax on the interest earned on U.S. savings bonds. If they do not include the interest in income in the years it is earned, they must include it in income in the year in which they cash in the bonds. However, when taxpayers cash in certain savings bonds under an education savings bond program, they may be able to exclude the interest from income.
10. Employer-Provided Educational Assistance: If someone receives educational assistance benefits from his employer under an educational assistance program, he or she can exclude up to $5,250 of those benefits each year. This means the employer should not include those benefits with the employee’s wages, tips, and other compensation shown on Form W-2, box 1. This also means that the employee does not have to include the benefits on the income tax return. Since the assistance is not included on the tax return, the employee cannot use it to determine any other deductions or credits.
11. Business Deduction for Work-Related Education: An employee who can itemize deductions may be able to claim a deduction for the expenses he paid for work-related education. The employee’s deduction will be the amount by which the qualifying work-related education expenses plus other job and certain miscellaneous expenses (except for impairment-related work expenses of disabled individuals) is greater than 2 percent of his or her adjusted gross income. An itemized deduction reduces the amount of income subject to tax. Self-employed individuals can deduct expenses for qualifying work-related education directly from their self-employment income. This reduces the amount of income subject to both income tax and self-employment tax. Work-related education expenses may also qualify the individual for other tax benefits, such as the AOTC and lifetime learning credits (discussed above). Taxpayers may qualify for these other benefits even if they do not meet the work-related business deduction requirements listed above. Also, work-related education expenses may qualify a taxpayer to claim more than one tax benefit. Generally, taxpayers may claim any number of benefits as long as they use different expenses to figure each one.
12. Tuition and Fees Deduction: This is a trap for the unwary, as, for 2015 and beyond, there is no deduction for qualified tuition and fees. For 2014 and prior, a deduction of no more than $4,000 (based on modified adjusted gross income) for qualified tuition and fees was allowable.
Michael Sonnenblick, J.D., LL.M., currently serves as an editor/author with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters. He holds a J.D. degree from Boston University School of Law and an LL.M. in Taxation from New York University Law School. A member of the New York Bar, Michael has 20 years of tax experience, including service with a major Wall Street bank and international law firms. In addition, he has represented clients before the IRS. Michael’s specialties include individual taxation and retirement planning.