Education Tax Credits and Deductions

Even if you are a student you may have to file a tax return in 2010 for the 2009 tax year. For example, if you were self-employed for some portion of the tax year and earned more than $400.00 during that self-employment, you will have to file a federal tax return and pay the necessary self-employment tax (Social Security and Medicare). You may also be required to pay Medicare and Social Security tax on tips that you did not report to your employer or if you worked for a church or religious organization that was exempt from those taxes.

There are many forms of income that students often receive which qualify as taxable income. Some of those include:

• Payment for services performed,
• Income earned through self-employment,
• Income earned through investments, and
• Some scholarships and fellowships

Allowances received through the Reserve Officers’ Training Corps are tax-exempt, but payments made over the summer qualify as taxable income.

Foreign students who are resident aliens may be subject to some of the same taxes as U.S. citizens.

There are two major educational tax credits available for students to offset the cost of education:

The American Opportunity Credit (formerly The Hope Credit)

• This education credit applies for the first four years of post-secondary school education, such as college or vocational school.
• You can claim up to $2,500 per eligible student, per year.
• The credit covers 100% of the first $2,000 of qualified tuition and related fees (books and other required course materials), plus 25% of the next $2,000.
• 40% of the credit is refundable, so you may receive $1,000 per eligible student as cash back even if you owe no taxes.
• Each student for which you apply for the credit must have been enrolled at least half time for at least one academic period which began during the tax year.
• The credit is phased out for individuals making more than $80,000 and for married couples filing jointly who make over $160,000.

The Lifetime Learning Credit

• This education credit applies to undergraduate, graduate, and professional degree courses, and even post-graduate courses that help improve your job skills.
• The credit is available for all years of post-secondary education, and also for adult and continuing education courses. There is no minimum enrollment.
• Your credit equals 20% of the first $10,000 of post-secondary tuition and fees you pay during the year, totaling no more than $2,000 (per tax return, not per student).
• The amount of the credit is gradually phased out if your income is between $48,000 and $58,000 ($96,000 and $116,000 if filing a joint return), and completely phased out for incomes of $58,000 or more ($116,000 or more if filing jointly).

You may claim either credit for education expenses you paid for yourself, your spouse, or your dependent; but you may not take the credit for yourself if you are claimed as someone else's dependent.

You cannot apply for both The Lifetime Learning Credit and The American Opportunity Credit for the same student in the same year. If you claim either credit, you cannot claim the Tuition and Fees Deduction, but you may still claim the Student Loan Interest Deduction:

Student Loan Interest Deduction

If you have started to pay back your student loan(s), you may be able to reduce your taxable income by up to $2,500 of the interest you have paid. This includes the one time loan origination fee charged by your lender.

To qualify, the loan must have been a commercial loan taken out exclusively for the purposes of higher education. The loan may only apply to a student who is enrolled at least half-time in a degree program and the student must be you, your spouse, or your dependent.

You do not need to itemize to claim the Student Loan Interest Deduction.

The amount of your deduction will begin to phaseout at an adjusted gross income of $60,000 ($120,000 if married filing jointly) and you will not be able to take the deduction if your gross income is $75,000 ($150,000 if married filing jointly) or higher.

Tuition and Fees Deduction

You may be able to claim a deduction of up to $4,000 of qualifying tuition and fees paid during the tax year for you, your spouse, or a dependent. You may deduct any qualified expenses up to $4,000, even if you paid with the proceeds of a loan or if the student is only enrolled part-time. If you take the Tuition and Fees Deduction and you are also paying off student loan interest, you may take the Student Loan Interest Deduction as well.

You do not need to itemize to claim the Tuition and Fees Deduction.

You will not be able to take this deduction if your filing status is married filing separately, if you are qualified to be claimed as a dependent on another tax return (whether or not you are actually claimed), or if your adjusted gross income is higher than $80,000 ($160,000 if married filing jointly). You may not claim the Tuition and Fees Deduction if you are taking either The Lifetime Learning or The American Opportunity Credit.

Important Exception: The costs of obtaining a doctoral degree (a PHD) are not deductible.

Qualified Tuition Programs (QTPs) - 529 College Savings Plans

A Qualified Tuition Program, or "529 Plan" (named for the section of tax code which describes it), is a special state-sponsored account set up to pre-pay for college expenses. The owner of the account can make contributions which may be withdrawn by the beneficiary when he/she attends college (or other eligible educational institute). This money may be withdrawn tax-free if the money is used for qualified education expenses at an eligible institute of higher learning. 529 Plans have no age or income restrictions for contributions or withdrawals, and the only limit on contribution amounts is that contributions may not be more than the amount required to pay the beneficiary's qualified education expenses.

Qualified Education Expenses for 529 Plans / QTPs:

• Tuition
• Books
• Supplies required for class attendance
• Computer (if required for class attendance)
• Internet Access (if not provided by the school and required for class attendance)
• Room and Board (if the student is enrolled at least half-time)
• Special Needs Services and Expenses

Coverdell Educational Savings Accounts - Coverdell ESAs

A Coverdell ESA is an account sponsored by a bank or other financial institution and is set up to pre-pay for any educational expenses. Contributions to Coverdell ESAs may be used for college expenses or for private schooling for grades K-12. The account's beneficiary must be at least age 18 to withdraw Coverdell funds, and must withdraw the funds before age 30 or the funds will be distributed and taxed. If the age requirements are met, the funds may be withdrawn tax-free. If the beneficiary turns age 30 before withdrawing the funds, they may avoid taxation by transferring the account to another qualifying relative or by rolling the ESA into a 529 Plan. Coverdell ESAs have certain other restrictions that 529 Plans do not.

Coverdell ESA Restrictions and Limits:

• Funds must be withdrawn or transferred after the beneficiary is age 18, but before age 30
• Qualified expenses do not include computers or internet access
• You may not contribute if your income is more than $110,000 ($220,000 if married filing jointly)
• There is a maximum annual contribution of $2,000 per beneficiary (not per account and not per contributor)

Qualified Education Expenses for Coverdell ESAs:

• Tuition
• Books
• Supplies required for class attendance
• Special Needs Services and Expenses
• Room and Board (if the student is enrolled at least half-time)

Find more details on education tax credits and education deductions in Publication 970, Tax Benefits for Education.