4 Ways to Save on Taxes When You Fund Higher Education

It is tax time – whether we like it or not! And you could save significant tax dollars if you recently funded your kids’ college education or your own. Here is what you need to know.

Your children are in college. You are determined to pay for their education. It is a lot of money! You wonder if Uncle Sam helps you here – I mean, in the form of tax incentives. Well, in fact, he does.

Thanks to the current laws, yes you could save on taxes when you pay for higher education. While the finest details are in this IRS Publication 970, here are four ways you can get some tax reprieve when you fund a college education:

1. American Opportunity Tax Credit (aka AOTC)

This credit is, indeed, the most generous tax incentive available when you fund a college education. If eligible, you could get a maximum of $2,500 tax credit per child per year during their undergraduate years. Yes, per child per year! In other words, if you are like me and fund four-year undergrad education for three kids, your total tax savings could be as high as $30,000 (3 X 4 X $2,500). Isn’t this great?

The $2,500 credit per child is arrived at by looking at the first $4,000 in qualifying education expenses: 100% of the first $2,000 + 25% of the next $2,000 expenses. The caveat is that you cannot combine this credit with a 529 distribution. For example, if your qualified expenses were $10,000, and you took a 529 distribution of $7,000 during the year, you would have only $3,000 available for consideration towards the AOTC credit. No double-dipping, please!

It is important to note that AOTC is a dollar-for-dollar tax credit, not a tax deduction! To understand the difference, let us look at a married filing jointly couple with a taxable income of $100,000, who are in 25% marginal tax bracket, and owe $16,000 in taxes.

A tax credit of $5,000 would reduce their tax bill to $11,000 (down from $16,000). On the other hand, a tax deduction of $5,000 would reduce their taxable income to $95,000 and based on a 25% marginal tax bracket, would reduce their tax bill to $14,750 (a reduction of 25% of $5,000 assuming all else is same).

Finally, eligibility for this credit depends on your modified adjusted gross income (aka MAGI). For example, in 2016, a married couple filing taxes jointly are eligible for: full credit if MAGI is less than $160,000, no credit if MAGI is above $180,000, and partial credit for AGI between $160,000 and $180,000. For single filers, the MAGI partial-credit range is $80,000-$90,000.

2.  Lifetime Learning Credit

The biggest limitation for AOTC is that it applies only to costs during undergraduate years. If you are considering funding for your child’s graduate study or your own late-career education, you are out of luck with AOTC.

However, a second tax credit called a Lifetime Learning Credit comes to your rescue in such situations. This credit offers a dollar-for-dollar tax reduction equal to 20% of qualified expenses of up to $10,000 per tax return, which would result in a maximum of a $2,000 tax credit.

Note the difference: per tax return, not per student. In other words, you can take a maximum of $2,000 total per tax return in Lifetime Learning Credit irrespective of the number of students in the household who used Lifetime Learning during the year.

MAGI limits are lower compared with AOTC. For example, in 2016, these limits for married couples filing jointly are $111,000-$131,000, and for single filers $55,000-$65,000.

Just like AOTC, Lifetime Learning offers a more valuable tax credit, as opposed to a tax deduction. Remember, credits reduce your tax liability dollar-for-dollar, while deductions reduce your taxable income.

Finally, just like AOTC, you cannot combine this with the distribution amounts of 529 funds.

3. Tuition and Fees Deduction

Because AOTC and Lifetime Learning offer dollar-for-dollar tax credits, they are generally considered superior tax breaks. However, there is a small set of situations in which you cannot use either AOTC or Lifetime Learning Credits.

For example, let us say your MAGI is $140,000 and you are funding your child’s graduate education. You are ineligible for AOTC because the funding is not for undergraduate education, and you do not qualify for Lifetime Learning because your MAGI exceeds the Lifetime Learning Credit’s limits.

Here comes your choice: The Tuition and Fees Deduction.

The biggest advantage for this deduction is that it is offered as an adjustment to your income (also known as an above-the-line deduction). In other words, you can claim this deduction even if you do not itemize deductions on your tax return.

So, what are the rules?

  • Maximum deduction amount is $4,000 per year per tax return.
  • The Tuition and Fees Deduction has its own MAGI limits: For 2016, married filing jointly receives the full $4,000 deduction for MAGI less than $130,000; a $2,000 deduction for MAGI between $130,000 and $160,000; and no deduction for MAGI more than $160,000. The MAGI range is $65,000 – $80,000 for single filers,
  • Similar to the credits, you cannot combine the deduction with the distribution amounts of 529 funds.
4. Student Loan Interest Deduction

This deduction is offered when you are paying back a loan you have taken for financing your education. Notice what you are deducting: It is not your entire loan payment, only the interest portion of the payment.

If eligible, you can deduct up to $2,500 per year per tax return. And the actual amount you can deduct depends on your MAGI for the year. For example, in 2016, if you are single, and

  • Your modified AGI is less than $65,000, you can deduct up to $2,500 of your interest payments.
  • Your modified AGI is more than $80,000, you cannot deduct any of your interest payments.
  • Your modified AGI is between $65,000 and $80,000, you can deduct anywhere between $0 and $2,500 of your interest payments.

For married filing jointly, these phase-outs are between MAGI limits of $130,000 and $160,000.

Finally, similar to the Tuition and Fees Deduction, this is an adjustment to income, not a tax credit. You are not required to itemize deductions on your tax return to claim it.

So, what do you think? Are you determined to send your kids to college and fund their education? Are you looking for ways to save on taxes in the process? If so, hope this article provided you some useful information. For a customized solution, please consult with your tax adviser or accountant. Good luck!

About me

Vid Ponnapalli
Vid Ponnapalli, MS, CFP®, EA
I provide customized Financial Planning and Investment Management services for Generation X professionals.

Connect with me

Follow me on Twitter

732 784 2840

Our Address

331 Newman Springs Road,
Building 1, 4th floor, Suite 143,
Red Bank NJ 07701

All written content on this site is for information purposes only. Opinions expressed herein are solely those of UNIQUE FINANCIAL ADVISORS LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.

The post 4 Ways to Save on Taxes When You Fund Higher Education appeared first on Unique Financial Advisors.

About the author

Vid Ponnapalli, MS, CFP®, MPAS®,CRPC®

I am a Fee-only financial advisor dedicated to working with individuals and families that are keen or organizing their financial life. I believe today’s financial planning need is under-served by traditional financial planning methods, mainly due to minimum income or net worth levels requirements. My goal is to contribute and change this paradigm. So, after a 20+ years career in financial services industry, I launched Unique Financial Advisors in 2014. I am eager to guide you through life’s financial decisions!

I am a CERTIFIED FINANCIAL PLANNER™ practitioner with an MS in Personal Financial Planning. I hold Master Planner Advanced Studies (MPAS®) and Chartered Retirement Planning Counselor (CRPC®) designations. I am a current active member of:

NAPFA (country's leading professional association of Fee-Only financial advisors)
FPA ( Financial Planning Association)
XYPN (A Financial Planners network focused on Generation X and Generation Y clients)

“My Mission is to help you achieve financial security by providing Fee-Only Financial Planning services with a relentless focus on Personal Attention and Trust.”

1. Fee-Only: I do not accept sales commissions; I do not sell financial products such as Investments and insurance. I work solely for you!

2. Personal Attention: I take pride on providing personal attention. I take the time to answer your questions and explain matters in simple, clear terms.

3. Trust: I strive for ethical long term relationships. Your peace of mind and exceptional client service are at the forefront of my agenda.

My wonderful wife, Maha and I live in Holmdel, NJ. Our three young boys are on their path to settling down in life. When I am not working on Financial Planning, I enjoy hiking, skiing, and spending time with family.

To learn more about me and my services, please schedule a free consultation TODAY!

Leave a Reply

Copyright 2014 FiGuide.com   About Us   Contact Us   Our Advisors       Login