Getting a college education is expensive. It is also a great investment in your future as well as the future of your child or grandchild.

There are some tax benefits that will assist in the cost of a college education.

The new stimulus bill passed on December 27, 2020 called the Consolidated Appropriations Act (“CAA”) made some changes to college tax benefits.

First, let us discuss some tax credits for college education expenses.

Tax credits are much better than a tax deduction.  Tax credits reduce your tax “dollar for dollar”.  For example: $2,000 tax credit saves a taxpayer $2,000 of tax. The Lifetime Learning Credit and American Opportunity Tax Credit are the two college education credits.

Before the stimulus bill, the Lifetime Learning Credit was worth up to $2,000 per student annually and its phase out range was for modified adjusted gross income (MAGI) between $59,001 and $69,000 for unmarried individuals (and $118,001 and $138,000 for married filing joint filers). The CAA also increases the phase out range to MAGI of $80,001 and $90,000 for unmarried individuals (and $160,001 and $180,000 for married filing joint filers). 

With the alignment under the CAA, the Lifetime Learning Credit and American Opportunity tax credit now have the same credit amounts and phase out ranges. The American Opportunity Tax Credit remains at $2,500 of total benefits and the refundable portion of the credit is $1,000. The Lifetime Learning Credit offsets income tax, but it is not a refundable credit. Essentially, if a taxpayer claims the Lifetime Learning Credit it will reduce their income tax, but they cannot get a refund from the credit (where the credit exceeds the tax due). The American Opportunity Tax Credit can fully zero out income tax and result in a refund.

Second, there are also some benefits for tax deductions for tuition and fees.

A tax deduction reduces your income subject to tax. For example, if a taxpayer is in a 25% bracket, a $2,000 deduction saves about $500 of income tax ($2,000 x .25). The Tuition and Fees deduction in 2020 could be up to $4,000 at lower income levels or up to $2,000 at middle income levels. If your 2020 MAGI allows you to be eligible, you can claim the deduction. This is an ‘above the line’ deduction and does not have any impact on your itemized deductions. Here are the income thresholds:

• For 2020, a taxpayer with a MAGI of up to $65,000 ($130,000 for married filing jointly) could deduct qualified expenses up to $4,000.
• For 2020, a taxpayer with a MAGI between $65,001 and $80,000 ($130,001 and $160,000 for married filing jointly) could deduct up to $2,000.
• For 2020, the allowable 2020 deduction was phased out and was zero if your MAGI was more than $80,000 ($160,000 for married filing jointly).

The federal Tuition and Fees deduction is not available after 2020.  Many states also offer their own state college tuition deduction so do not overlook the state income tax benefits available for college related costs and college saving programs.

Each education tax benefit has its own requirements.

There are also other education tax opportunities you may be able to take advantage of, including a Section 529 tuition plan and a Coverdell Education Savings Account.   Those other education tax opportunities have impacts on the credits and deductions you may claim as well.   The American Opportunity Credit may be claimed in the same year that a tax-free distribution is made as long as the same expenses are NOT used to calculate the tax-free distribution AND the American Opportunity Tax Credit.

For example, if you take $12,000 out of a 529 college savings plan to pay for tuition, you cannot use that $12,000 of tuition expenses to claim the American Opportunity Tax Credit also.  This coordination of education benefits provision is exactly why it helps to have a tax preparer who understands education funding so that you can make the most of the tax benefits that you qualify for.

At Wegner CPAs, we run this analysis as part of our tax preparation process to ensure our clients are getting the maximum benefits from college education costs.