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By Marcia Richards Suelzer, Toolkit Staff Writer
Federal tax law provides a number of incentives to encourage Americans to obtain an education. These incentives range from tuition reimbursement under an employer-provided plan to a deduction for tuition and fees. Because the rules and requirements vary, it can be difficult to determine how to maximize your benefits. Planning is also important because you are not able to "double dip" and use the same expenses for two different tax breaks, or to claim certain tax breaks for the same person in a single tax year.
Think Ahead. The IRS lists twelve tax breaks available to offset the cost of education (not including tax-free scholarships):
This article focuses on the first three of these. Consult IRS Publication 970, Tax Benefits for Education, to learn about the others listed.
Credits vs. Deductions
As a general rule, if an expense can be applied toward a tax credit or toward a tax deduction, you should take the tax credit. Why? A credit reduces your tax bill dollar-for-dollar, but a tax deduction only offsets income that your tax is based upon. This means that a deduction is only valuable to the extent of your tax bracket.
Example. Although she is earning a decent salary, Megan Hunter realizes that her lack of an undergraduate degree will eventually limit her career progression. She decides to attend college. In 2011, she is eligible for the tuition deduction and the American Opportunity tax credit--but she can only claim one. (For the sake of this example, assume the maximum she can claim as a deduction or as a credit is the same: $2,000.)
In order to decide which to claim, Megan does some quick math.
|Tax Item||Tuition Deduction||AOTC|
|Tuition Deduction||$ 2,000||-0-|
|Adjusted Gross Income||$58,000||$80,000|
|American Opportunity Tax Credit||-0-||$2,000|
Tax Savings by Claiming the AOTC: $1,513
When Deductions Are Better
However, in tax law, any general rule is subject to exceptions. And maximizing your educational tax breaks is no exception to the rule.
When is a tax deduction better than a tax credit? You may want to think about using the deduction rather than the credit when:
Tip. The tuition and fees deduction is a rare bird among tax deductions. It is a deduction from your gross income, which means that you can claim the deduction even if you do not itemize.
As 2011 draws to a close, these factors may play into your decisions regarding tax breaks for education. First, and possibly foremost, the tuition and fees deduction expires at the end of this year. Therefore, if you don't use it this year, it's unlikely you will have the opportunity to do so in the future. In contrast, both the American Opportunity Tax Credit and the Lifetime Learning credit do not expire until the end of 2012.
Plus, the amount that you can claim for the tuition and fees deduction is $4,000, considerably higher than the AOTC which is capped at $2,500 per student and the Lifetime Learning credit, which is capped at $2,000 per tax return. On the downside, the income phase-out for the tuition and fees deduction is considerably lower than that for the AOTC, although it is higher than the phase-out range for the Lifetime Learning credit.
|Tuition Deduction||American Opportunity Credit||Lifetime Learning Credit|
|$65,000 - $80,000||$80,000 - $90,000||$50,000 - $60,000|
|$130,000 - $160,000||$160,000 - $180,000||$100,000 - $120,000|
Timing Your Tuition Payments
For each student, you can only claim one credit in a year, although, you can claim one credit for one student and the other credit for another student. Similarly, you cannot claim the tuition and fees deduction in the same year that you claim either education tax credit. You must choose to either take the credit or the deduction, and should consider which is more beneficial for you.
That said, year-end offers you the unique opportunity to claim both a deduction and a credit attributable next year's expenses. By timing your payments, you will be able to claim the tuition and fees deduction for payments made in 2011, while preserving your right to the AOTC for the expenses that you pay in 2012. (Of course, you cannot use the same expenses twice. But, with the tuition, fees and book costs being what they are, this should not pose a problem for most taxpayers.)
Example. Assume the same facts as the earlier example. Megan Hunter has the following expenses for Spring Semester 2012:
Tuition: $7,000 Enrollment Fees: $450 Books: $420 Lab Equipment: $200
The tuition and fees deduction can apply only to the cost of tuition and required enrollment fees. So she should make some payments now, to count in 2011, and pay the rest after the start of 2012, in order to maximize her tax breaks. Because Megan's income is $60,000, she can claim the full $4,000 deduction on her 2011 income tax return for tuition costs. Thus, she will have $3,000 in tuition, plus the fees, books and lab equipment available for the AOTC, thus enabling her to claim the maximum credit on her 2012 income tax return.
It is not often that taxpayers the wide variety of tax breaks available to them as they have for educational expenses. Set aside time to review the rules before year-end so that you maximize your tax savings.