Guide to Education Tax Credits and Deductions

All things being equal, I’d rather have a tax credit than an income deduction when I file my tax return. Tax credits decrease the amount you owe the government (or increase your refund) dollar-for-dollar, while a deduction reduces your tax only by your tax rate. In other words, if your tax rate is 15%, a $100 deduction saves you only $15 in taxes. If offered a tax credit for $100 or a deduction for $100, choose the credit every time (assuming you pay taxes).

The choice isn’t always that easy, though, because the credit may be much different than the deduction amount. In this case, you’ll need to calculate how much in tax the deduction saves you compared to the credit. This provides a true apples-to-apples comparison. If you’re a student you have a number of opportunities for choosing between a credit or a deduction. Fortunately, tax software like TurboTax will help guide you to choosing the option that gives you the biggest refund.

The American Opportunity Tax Credit

As I wrote earlier this month, the American Opportunity Tax Credit is one of the most generous education benefits available, and by the time you’re reading this, will likely have been extended for another two years. The credit is worth up to $2,500 for qualified tuition and related expenses for each of the 4 years of college. Related expenses include expenses like books, supplies and equipment needed for a course of study if these items are required as a condition of enrollment or attendance.

Even if you don’t owe any tax, the American Opportunity Tax Credit can still provide you with a tax refund of up to $1,000. This is perfect for students who are not working, looking for a job, or are working part-time

The full credit is available to those whose “modified adjusted gross income” does not exceed $80,000 and $160,000 for single and joint filers, respectively. If your income exceeds these thresholds, your credit is reduced.

The Lifetime Learning Credit

The Lifetime Learning Credit helps parents and students pay for post-secondary education. Because the credit is not limited to the first four years of college or to full time students as the American Opportunity Credit is, the Lifetime Learning Credit is helpful to graduate students, students who are only taking one course and those who are not pursuing a degree.

This credit provides a benefit of up to $2,000 for tuition and related educational fees. If you qualify for more than one of the education credits or deductions, you can only claim one per year. No double dipping is allowed!

There is no limit to the number of years that a student can qualify for the Lifetime Learning Credit.

The credit, however, begins to phase out when income exceeds $50,000 (single) and $100,000 (joint). It is completed eliminated when income reaches $100,000 (single) and $120,000 (joint).

Tuition and Fees Deduction

The Tuition and Fees Deduction is taken as an adjustment to income. So even if you don’t itemize, you can benefit from this deduction. Because the income thresholds ($80,000 single and $$160,000 joint) for this deduction are higher than those for the Lifetime Learning Credit, this deduction may prove more valuable. The deduction is worth up to $4,000. The rules for the Tuition and Fees Deduction are very similar to those for the Lifetime Learning Credit.

Don’t forget that you can still qualify for all the above education benefits even if you paid your tuition and expenses with a student loan. Whether you paid the bills with your money or borrowed money, you can qualify for the benefits. The IRS offers worksheets to help you determine which benefit will help you the most, but tax software makes this process significantly easier. Enter your total tuition expenses paid during the year, and the software will choose the right option that gives you the biggest refund.