Instead of writing a check to the IRS, why not get a tax break from them? Give yourself up to $2,500 with the American Opportunity tax credit. This tax credit reduces your taxes dollar for dollar and is like putting money directly into your pocket. You may receive up to $2,500 in Hope credits if you are in an undergraduate degree or certificate program. (Unfortunately, graduate and professional programs are excluded from this tax credit.)
To figure out how much of a Hope tax credit that you can claim, look at the total amount of money that you paid out of your own pocket for tuition. The American Opportunity tax credit can only be used for tuition, not room and board and other expenses. Once you know how much you've paid out of pocket for tuition, you can claim 100 percent of the first $2,000 and 25 percent of the next $2,000 that you paid. In other words to claim the full $2,500 you must have paid at least $4,000 in qualified education expenses.
To claim an American Opportunity tax credit, file your taxes using Form 1040 or 1040A and attach Form 8863 Education Credits. There are a few other stipulations attached to the credit, which are that the you must be enrolled at least half-time, be enrolled in a program that leads to a degree, certificate or other recognized educational credential and be free of any felony conviction for possessing or distributing a controlled substance.
You must also meet the income requirements. For a single taxpayer you can get the full credit if your modified adjusted gross income does not exceed $80,000. If it does but is below $90,000 you can claim a partial credit. For married couples filing jointly you can get the full credit if your income does not exceed $160,000. If you earn more but are still below $180,000 you can claim a partial credit.
The other tax credit you may receive is up to $2,000 with the Lifetime Learning credit. The Lifetime Learning credit is similar to the American Opportunity tax credit and reduces the tax you owe dollar for dollar. But unlike the American Opportunity, the Lifetime Learning credit may also be used for graduate school or even continuing education. However, you cannot claim both an American Opportunity and a Lifetime Learning credit in the same year. It is usually to your advantage to claim the American Opportunity tax credit for undergraduate expenses. If you are taking continuing education courses or are a graduate school student, then you have no choice but to take the Lifetime Learning credit.
The maximum amount of the Lifetime Learning credit is $2,000 per tax return, which is figured by taking 20 percent of what you pay for tuition (not room and board or other expenses) up to $10,000. This means that to claim the full $2,000 credit, you must spend $10,000 or more out of your own pocket on tuition. Remember, money that is already receiving a tax benefit like scholarships that are tax-free or 529 Savings Plan money doesn't count in figuring out how much you spent. The IRS doesn't allow double-dipping.
Eligible courses can be part of a postsecondary degree program or taken to acquire or improve job skills. Eligible educational institutions include any college, university, vocational school or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. This includes virtually all accredited, private or public, nonprofit and proprietary (privately owned, profit-making) postsecondary institutions. Also, the felony drug conviction rule that might prevent you from getting an American Opportunity tax credit does not apply for the Lifetime Learning credit.
You must also meet the income requirements. For a single taxpayer you can get the full credit if your modified adjusted gross income does not exceed $48,000. If it does but is below $58,000 you can claim a partial credit. For married couples filing jointly you can get the full credit if your income does not exceed $96,000. If you earn more but are still below $116,000 you can claim a partial credit.
Since you can claim only one of the credits per year, make sure you take advantage of the right one. If you qualify for both then you probably want to use the American Opportunity tax credit since it lets you qualify for the full amount while using less of your own money.
Other Tax Deductions
Tax deductions are not as good as tax credits but they do reduce your taxable income, which means you will still pay less taxes. One of the most common education deductions is for money that you pay for tuition and fees. This can be the tuition that you paid for yourself, a spouse or a dependent child. You can deduct up to $4,000 of tuition expenses (not room and board or other expenses) that you paid as long as you are not also claiming an American Opportunity or Lifetime Learning credit. This is part of the no double-dipping rule, which also means that you cannot deduct any tuition expenses that you paid with tax-free money such as funds from scholarships.
To claim the full deduction you must also meet income requirements. If you are a single taxpayer with a modified adjusted gross income of $65,000 or less or a couple filing jointly with an adjusted gross income of $130,000 or less you can take the full deduction. If you make more but still less than $80,000 as a single taxpayer or $160,000 as a joint taxpayer you can deduct only up to $2,000 in tuition expenses.
All student loan interest that you pay is tax deductible up to $2,500 per year. The loan must have been used for qualified higher-education expenses, including tuition, fees, room and board, supplies and other related expenses. Also the maximum allowable deduction is gradually reduced for single taxpayers whose modified adjusted gross income exceeds $55,000 but is below $70,000 and for married taxpayers filing jointly whose modified adjusted gross income exceeds $115,000 but is below $145,000.
You can usually count as interest the loan-origination fees (other than fees for services), capitalized interest, interest on revolving lines of credit and interest on refinanced student loans, which include both consolidated loans and collapsed loans. You can also count any voluntary interest payments that you make. To claim the deduction you should receive form 1098-E from your lender or loan servicer.
If you have a generous employer you might be able to receive up to $5,250 of tax-free employer provided educational assistance benefits each year. This means that you may not have to pay tax on amounts your employer pays for your education including payments for tuition, fees and similar expenses, books, supplies and equipment. This can be used for both undergraduate and graduate-level courses. Plus, the payments do not have to be for work-related courses. However, you cannot use any of the tax-free education expenses paid for by your employer as the basis for any other deduction or credit, including the American Opportunity and Lifetime Learning credits.
Tax questions are never easy and it is essential that you talk to a professional accountant. In addition, tax laws are constantly changing. To get the latest (and free) information, surf over to the IRS website at www.irs.gov or schedule a phone or personal appointment. You can call with questions to (800) 829-1040, or try the IRS's Everyday Tax Solutions service by calling your local IRS office to set up an in-person appointment. If you have access to TTY/TDD equipment, call (800) 829-4059.