Education Credits and Deductions

A reader asked about education credits.  These are complicated, as there are credits and deductions for tuition paid, deductions for interest on student loans, tax-free investments, employer provided tax free education, and may other ways to take tax benefits for education. Massachusetts also has deductions for tuition paid.

I’ll touch on just a few items in this.  (IRS Publication 970 which covers education tax benefits is over 90 pages long, so I definitely can’t cover everything here.)

Let’s start with the difference between a credit and a deduction.  A deduction lowers your income.  A credit lowers your tax due.  For example, let’s say you have income from a job of $85,000 and a tax liability of $7856 (making assumptions on exemptions and itemization).  If you have a $4000 deduction, then your adjusted gross income (AGI) is $81,000 leading you to have a tax liability of $7256.  That is a $600 drop in taxes.  If you have a $2000 credit, then your AGI is $85,000, but your taxes are reduced by $2000 to $5856.  For most parents of college students, the credits are better, but it is very dependent on your specific situation.

For college students, there is a tuition and fees deduction, a Lifelong Learning Credit, and an American Opportunity Credit. If your child is in college, under 24 years old, and your dependent, then you, as the parent, can take the education credit or deduction or the student can.  The college should provide a 1098-T form which provides the amount of tuition that was paid.  There are income limits and other restrictions which prevent the use of any education tax benefits.  Your tax professional or your tax software will select your best option.

The tax benefits help, but how will you pay for college.  Some people withdraw money from a 401k or IRA. If you are under 59.5 years old, this withdrawal usually results in a 10% penalty payment in addition to taxes due (since the money is considered income).  There are a few exceptions. If you spend the money on higher education, then the 10% penalty is waived if the money is from an IRA. It is not waived if the money is from a 401k.  If you have a 401k from a former company and a child going to college in the next few years, it is worth discussing with your tax adviser or financial planner about moving the money to an IRA. You may not plan on using this money, but it is worth having it in an IRA just in case you need it.

As with all tax advice, each individual situation is different and there are exceptions.  Tax information provided here is not intended to be used to avoid any federal or state penalties that may be imposed on the reader.

Beth Logan is an Enrolled Agent for Kozlog Tax Advisers in Chelmsford.  She can be reached at info@kozlog.com.