Now that the school year has begun, many college students—and their parents—are looking for ways to make the cost of higher education more affordable. But beyond grants and scholarships, the federal government offers several kinds of educational tax benefits that many people are not aware of.
The American Opportunity credit
The American Opportunity credit (formerly the Hope credit) is a tax credit available for the first four years of a student's undergraduate education, provided the student is attending school at least half-time in a program leading to a degree or certificate.
The credit is worth up to $2,500 in 2023 (it's calculated as 100% of the first $2,000 of qualified expenses plus 25% of the next $2,000 of expenses).
The credit must be taken for the tax year that the expenses are paid, and parents must claim their child as a dependent on their tax return to take the credit.
To be eligible for the credit, your income must fall below certain limits. In 2023, a full credit is available to single filers with a modified adjusted gross income (MAGI) below $80,000 and joint filers with a MAGI below $160,000.
A partial credit is available to single filers with a MAGI between $80,000 and $90,000 and joint filers with a MAGI between $160,000 and $180,000.
One benefit of the American Opportunity credit is that it's calculated per student, not per tax return. So, parents with two (or more) qualifying children in a given year can claim a separate credit for each child (assuming income limits are met).
The mechanics of claiming the credit are relatively easy. If you paid tuition and related expenses to an eligible educational institution during the year, the college generally must send you a Form 1098-T by February 1 of the following year. You then file Form 8863 with your federal tax return to claim the credit.
Lifetime Learning credit
The Lifetime Learning credit has a broader reach than the American Opportunity credit. As the name implies, the Lifetime Learning credit is available for college or graduate courses taken by anyone—you, your spouse, or your dependents--throughout their lifetime. Anyone may claim these credits even if those courses are taken on a less than half-time basis and don't lead to a formal degree.
However, this credit can't be taken in the same year as the American Opportunity credit on behalf of the same student.
The Lifetime Learning credit is worth up to $2,000 in 2023 (it's calculated as 20% of the first $10,000 of qualified expenses). It must be taken for the same year that expenses are paid, and you must file Form 8863 with your federal tax return to claim the credit.
In 2023, a full credit is available to single filers with a modified adjusted gross income (MAGI) below $80,000 and joint filers with a MAGI below $160,000.
A partial credit is available to single filers with a MAGI between $80,000 and $90,000 and joint filers with a MAGI between $160,000 and $180,000.
Unlike the American Opportunity credit, the Lifetime Learning credit is limited to $2,000 per tax return per year, even if more than one person in your household qualifies independently in a given year.
If you have more than one family member attending college or taking courses at the same time, you'll need to decide which credit to take.
Student loan interest deduction
The student loan interest deduction allows borrowers to deduct up to $2,500 worth of interest paid on qualified student loans. Generally, federal student loans, private bank loans, college loans, and state loans are eligible.
However, the debt must have been incurred while the student was attending school on at least a half-time basis in a program leading to a degree, certificate, or other recognized educational credential.
So, loans obtained to take courses that do not lead to a degree or other educational credential are not eligible for this deduction.
Your ability to take the student loan interest deduction depends on your income. For 2023, to take the full $2,500 deduction (assuming that much interest is paid during the year) single filers must have a MAGI of $75,000 or less and joint filers $155,000 or less.
A partial deduction is available for single filers with a MAGI between $75,000 and $90,000 and joint filers with a MAGI between $155,000 and $185,000.
Also, to be eligible for the deduction, an individual must have the primary obligation to pay the loan and must pay the interest during the tax year.
And the deduction may not be claimed by someone who can be claimed as a dependent on another taxpayer's return.
Borrowers can take the student loan interest deduction in the same year as the American Opportunity credit or Lifetime Learning credit, provided they qualify for each independently.
For more information, see IRS Publication 970.
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David Jaeger is a financial advisor at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or djaeger@canbyfinancial.com
Prepared by Broadridge Investor Communication Solutions, Inc. and Canby Financial Advisors. Copyright 2023. Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances.