Educational Tax Breaks
Tax & AccountingMarch 09, 2021

Education Tax Breaks Available for Students

Wolters Kluwer Updates Qualifying Credits, Deductions

(NEW YORK, NY, March 2021) — Students and families looking for education-related tax break opportunities have plenty to pick from if they know what’s available and where to look. Many tax provisions for saving on tuition and other school-related expenses remain in effect for those who qualify. One important change is that the Tuition and Fees Deduction is repealed starting in 2021.  In exchange, starting in 2021, the phase-out limits for the Lifetime Learning Credit are increased to match the phase-out limits for the American Opportunity Tax Credit.  The following information and tables include current education tax break updates and savings plan information.

 

Comparing Tax Credits

Two popular education tax breaks are The American Opportunity Tax Credit (AOTC), which provides up to a $2,500 credit for qualifying educational costs, and the Lifetime Learning Credit. The table below examines specifics and qualifications for each:

 


AMERICAN OPPORTUNITY TAX CREDIT LIFETIME LEARNING CREDIT
What it is An enhanced Hope Credit of up to $2,500 per student per year for the first four years of post-secondary qualified tuition and expenses. This credit has been made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015. A credit of up to $2,000 per return based on expenses for post-secondary education or courses to improve job skills.
Credit amount 1100% of the first $2,000 of qualified tuition and related expenses plus 25% of the next $2,000. Use Form 8863, Education Credits. 20% of the first $10,000 in qualifying expenses, to a maximum $2,000 credit. Use Form 8863, Education Credits.
Qualifying expenses
Qualified tuition and related expenses, including expenditures for course materials, such as books, supplies and equipment.
Tuition, student activity fees and course-related fees paid directly to the educational institution.
Credit phase-out ranges Modified adjusted gross income (MAGI) is $80,000-$90,000 for single filers, $160,000-$180,000 for joint returns.

Up to 40% of the credit amount is refundable if the taxpayer’s tax liability is insufficient to offset the nonrefundable credit amount.

These numbers are not subject to inflation adjustment.
MAGI limits are $59,000-$69,000 for single taxpayers for 2020 and $118,000-$138,000 for joint returns for 2020.
MAGI limits for 2021 are $80,000-$90,000 for single filers, $160,000-$180,000 for joint filers.
Who can/can’t claim it

Can’t be taken if married filing separately.

Can’t be taken by student claimed as dependent child on another person’s return, but parent can claim credit for paying dependent child’s expenses.

Student must be enrolled in program leading to degree or other recognized credential, studying at least half-time.

Can’t be used for graduate or professional level programs or by anyone with a felony conviction for a state or federal drug offense.

Cannot be claimed by the student if he or she has unearned income subject to the “kiddie tax.”

Can’t be taken if married filing separately.

Can’t be taken by a student if claimed as dependent child on another person’s return, but parent can claim credit for paying dependent child’s expenses.

What to watch out for

Can’t be taken if Lifetime Learning Credit or tuition and fees deduction is taken for the same student.

Can be taken in same year as a distribution from a Coverdell Educational Savings Account (Coverdell ESA) or qualified tuition program (529 plan), but not for same expenses.

Can be taken for expenses paid for with student loan.
Credit applies per student.

Can’t be taken if American Opportunity Tax Credit or tuition and fees deduction is taken for the same student.

Can be taken in same year as a distribution from a Coverdell ESA or 529 plan, but not for same expenses.

Can be taken for expenses paid for with student loan.

Credit applies per return.


Comparing ‘Above-the-line’ Deductions

The Tuition and Fees and Student Loan Interest Deduction are compared below.  The Tuition and Fees Deduction is repealed starting in 2021.


TUITION AND FEES DEDUCTION
STUDENT LOAN INTEREST DEDUCTION
What it is A deduction from gross income of up to $4,000 ($2,000 if modified adjusted gross income (MAGI) exceeds $65,000 for single filers or $130,000 for joint filers; no deduction if MAGI exceeds $80,000 and $160,000 respectively) based on expenses for post-secondary education. A deduction from gross income of up to $2,500 based on interest paid on a student loan for post-secondary education.
Credit amount 100% of the first $4,000 ($2,000 if MAGI exceeds $65,000 for single filers or $130,000 for joint filers) in qualifying expenses.

Taken on Form 1040.
100% of the first $2,500 in qualifying expenses.

Taken on Form 1040.
Qualifying expenses
Tuition, student activity fees and course related fees paid directly to the educational institution.
Loan may cover books, supplies, equipment, room and board, transportation and other necessary expenses in addition to tuition, student activity fees and course related fees paid directly to the educational institution. Interest payments are deductible for the entire period of the loan.
Deduction phase-out ranges

Full deduction is only allowed if MAGI is not greater than $65,000 for a single filer, or $130,000 for joint filers.

Taxpayers whose income exceeds $65,000 but not $80,000 may claim a $2,000 deduction; individuals filing jointly whose income exceeds $130,000 but does not exceed $160,000 may claim a $2,000 deduction. Taxpayers whose income exceeds $80,000 and $160,000 are denied the deduction. These numbers are not inflation adjusted.

For 2020 and 2021, MAGI is $70,000 - $85,000 for a single filer, $140,000 - $170,000 for joint filers.
Who can/can’t claim it

Can be taken by qualifying individuals, including themselves, a spouse or a dependent.

Can’t be taken if married filing separately.

Can’t be taken if claimed as dependent on another person’s return.

Deduction may be taken even for voluntary payment of interest.

Must have been in degree program and at least half-time student to take the deduction.
Can’t be taken if married filing separately.
Can’t be taken if claimed as dependent on another person’s return.

Can be taken only by the person who is responsible for the loan and who actually makes the payments.

What to watch out for

Can’t be taken if AOTC or Lifetime Learning Credit is taken for the same student.

Can be taken in the same year as a distribution from a Coverdell ESA or qualified tuition program but not for the same expenses.

Can be taken for expenses paid for with a student loan.

Deduction is taken on Form 8917, Tuition and Fees Deduction.

Deduction may be taken even for voluntary payment of interest.

 

529 Educational Savings Plans, Coverdell Education Savings Accounts

Below are tax break comparisons between Coverdell education savings accounts (Coverdell ESAs or ESAs) and 529 college savings plans (529 plans), also referred to as qualified tuition programs (QTPs).


TUITION AND FEES DEDUCTION
QUALIFIED TUITION PROGRAM PLANS
What it is A savings account for educational expenses in which earnings grow tax-free. Withdrawals also are tax free if used to pay for qualified educational expenses.

Three general types of 529 plans exist:

  • Pre-paid tuition plans — generally guaranteeing future tuition coverage at a state university.
  • State 529 college savings plans — generally sponsored by a state, allowing you to use saving plan proceeds to attend a state or private university.
  • Independent 529 plans — sponsored by a consortium of private colleges, whereby you can lock in current tuition rates for future years at participating schools.

In each savings program, investment earnings are not taxed if withdrawals are used for qualified expenses.

Contributions to state-sponsored programs are partially or fully deductible on some state tax returns.

Contribution Limits

$2,000 maximum annual contribution per year per beneficiary.

As with IRAs, contribution can be made up to the tax filing deadline which is April 15, 2020 for most states.

Can contribute to both a Coverdell ESA and a qualified tuition plan in the same year.

Contributions cannot be more than is necessary to provide for the higher education expenses of the beneficiary. These amounts are set by the state or educational institutions sponsoring the plan and may be in excess of $500,000 in some states such as California, New York, and Pennsylvania. In the case of many 529s, accounts can be opened with as little as $10 or $25 and contributions as little as $15 per pay period.

There are no other specific annual contribution limits for the plans.
Qualifying expenses

Can be used to pay for tuition, fees, books, supplies and equipment for both K-12 and post-secondary.

For K-12, can also pay for uniforms, transportation, supplementary items and services such as extended day programs, room and board, and purchase of computer technology and Internet access (but cannot be used for sports, games or hobby software unless it is predominantly educational).

For post-secondary education, can cover expenses for room and board if the student is enrolled at least half-time and the amount meets certain guidelines. Can also be used to fund a qualified tuition program.

Distributions can be used for accredited post-secondary books, supplies, equipment, room and board, transportation and other necessary expenses in addition to tuition, and student activity fees and course-related fees paid directly to the accredited post-secondary educational institution.

They also include amounts paid for computers and peripheral equipment, software, and internet access and related services if the items are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. Qualified expenses also include the reasonable cost of room and board if the beneficiary is enrolled at least half-time.

Qualifying expenses include registered apprenticeship programs and qualified education loan repayments (up to $10,000 for each).

Up to $10,000 per year can be used for qualified elementary and secondary education tuition.

Amounts may be rolled into ABLE accounts for the same beneficiary.

Contribution phase-out ranges

The phase–out ranges from modified adjusted gross income (MAGI) of $95,000–$110,000 for single filers, $190,000–$220,000 for joint filers; no phase out for corporation or other entities, including tax–exempt organizations. These numbers are not subject to inflation adjustment.

No income limitations.
Who can/can’t claim it

Beneficiary must be younger than 18 years old or be a special needs beneficiary in the year contributions are made.

Anyone can set up an account for a beneficiary as long as the annual contribution limits for that beneficiary are not exceeded.

Someone funding a qualified tuition program for another individual can use the annual gift tax exclusion or combine five years’ worth of exclusions in a single year. The beneficiary can exclude funds withdrawn from the qualified program from income if they are used for qualified expenses.

What to watch out for

Beneficiary is taxed on any withdrawals not used to pay for qualified educational expenses. (Penalty-free withdrawals can be made in connection with service academy appointments, i.e., Annapolis or West Point.)

All funds must be withdrawn by the time beneficiary reaches age 30 (except if special needs individual), but an account can be transferred from one beneficiary to another.

All contributions must be made in cash.

As with a conventional IRA, owner of the account can exercise wide discretion as to investments. The funds, however, cannot be used to reimburse the taxpayer for home schooling.

Check tax treatment of contributions for state income tax purposes.

Limited ability to change investment options.

Possible 10% penalty if distributions are not used for qualified expenses.

Beneficiary can be changed if new beneficiary is a member of the same family.

Penalty-free withdrawals can be made in connection with service academy appointments, such as Annapolis or West Point.

 

 

Exclusions

Several exclusions also are available for taxpayers related to education:

Bond interest: All or part of the interest on proceeds of qualified savings bonds (specifically, Series I bonds or qualified Series EE bonds issued after 1989) cashed to pay education expenses. For 2020, MAGI eligibility phase-out ranges are $82,350–$97,350 for single filers ($83,200–$98,200 for 2021), $123,550–$153,550 for joint returns ($124,800–$154,800 for 2021).

Employer assistance: For 2020 tax filing, employer-provided educational assistance (up to $5,250 annually) can be excluded from income for undergraduate or graduate level coursework and expenses.  During the period March 27, 2020 to December 31, 2025, permitted reimbursements may also include student loan repayments.

Scholarship funds: Scholarship money or tuition reduction from income up to the amount spent on qualified expenses; you generally cannot claim exclusion if scholarship or tuition reduction represents payment for teaching, research or other services. There is also an exclusion for Armed Forces and National Health Service Corps scholarship programs.

Student loans: The amount of a cancelled student loan is also excluded from gross income. (Normally, a cancellation of indebtedness counts as income.) The discharge must be made under the terms of a loan agreement and made because the person works for a specified period in certain professions for certain kinds of employers – for example, as a doctor or nurse in underserved areas.

 

Source: Wolters Kluwer CCH® AnswerConnect, 2021
Permission for use granted.

Mark Luscombe
Principal Federal Tax Analyst
Mark Luscombe, a CPA and attorney, is the principal federal tax analyst for Wolters Kluwer Tax & Accounting. He is the current chair of the Important Developments Subcommittee of the Partnership Committee of the American Bar Association Tax Section and speaks on a wide range of tax topics. He authors monthly columns in Accounting Today and TAXES magazine. Prior to joining Wolters Kluwer, he was in private practice with several Chicago-area law firms where he specialized in taxation.