Education is expensive. Even Congress knows that education is expensive, and they also know that better-educated people earn more money, which means they can pay more taxes. So they give students various tax breaks. (Well, that may not be exactly why, but the tax breaks are real.) Parents of students can get tax breaks too, if they’re helping to pay for their children’s education.
Here are the main education tax breaks in the U.S., and how you might be able to use them:
American Opportunity Tax Credit – The American Opportunity Tax Credit (“AOTC”) is a tax credit that applies to qualified education expenses paid for an eligible student during the first four years of higher education. The maximum annual credit is $2,500 per eligible student. The credit can be claimed by the student’s parents, if the student is a claimed as a dependent.
Note that a tax credit directly reduces the amount of tax you owe, which is better than a tax deduction, which only reduces the amount of income that is taxed. Even better, if the AOTC brings the amount of tax you owe to zero, you can get up to 40 percent of the remaining credit refunded to you as a tax refund.
Lifetime Learning Credit – The Lifetime Learning Credit (“LLC”) is a tax credit that applies to qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. The maximum annual credit is $2,000 per tax return. The credit may be applied toward undergraduate, graduate and professional degree courses, including job skills courses. Unlike the AOTC, there is no limit on the number of years you can claim the credit. This credit can also be claimed by the student’s parents, if the student is a claimed as a dependent.
529 College Savings Plans – 529 College Savings Plans (officially known as “Qualified Tuition Programs”) are set up and operated by states or educational institutions. Each account has a designated beneficiary. Contributions are not tax-deductible, but earnings are not subject to federal tax when used for qualified education expenses. Depending on the state, earnings may or may not be subject to state tax when used for qualified education expenses. Generally, accounts can be transferred between family members, such as to a younger sibling.
Coverdell Education Savings Accounts – A Coverdell Education Savings Account (“Coverdell ESA”) is similar to a Roth IRA, in that contributions are not tax-deductible, but earnings are tax-free if they are used to pay for qualified education expenses. Unlike most tax benefits, qualified expenses for purposes of a Coverdell ESA can be incurred during elementary and secondary education years, as well as during higher education. A Coverdell ESA may also be transferred between family members.
Savings Bonds for Education – Qualified taxpayers may exclude from their taxable income interest earned from qualified savings bonds if the interest was used to pay for qualified higher education expenses.