How can the tax code help you lower the cost of higher education?
College students spend money on basically three things: tuition, books and supplies, and room and board. Depending on the circumstances, Uncle Sam will allow you to reduce your taxes on the amounts you spend on tuition, books and course materials. (Room and board is considered a personal expenditure and is not deductible.)
The most popular way to do this is to take tax credits on those items, and the most common tax credit vehicle for students at Butler or any other four-year university or college is the American Opportunity Tax Credit. This is available to the person who pays for tuition and course materials, whether a student or their parent is footing the bill.
To qualify for the credit, a person needs to be attending his or her first four years of post-secondary education and taking at least half a full-time course load for one academic year. A maximum credit of $2500 per student is available for each $4,000 spent on tuition and course materials (which include books, supplies and other equipment needed for a course of study). That’s calculated based on 100 percent of the first $2000 spent on tuition and course materials, plus 25 percent of the next $2,000 on these items.
The second tax credit is the Lifetime Learning Credit, which only covers tuition. Because this credit requires no minimum course load, it’s available to taxpayers seeking new job skills or maintaining existing skills or used for individuals beyond the first four years of post-secondary education.
Let’s say a person is working a full-time job and taking one class a year in pursuit of her master’s degree. She would qualify for the Lifetime Learning Credit.
While the American Opportunity Tax Credit is computed per student, the Lifetime Learning Credit is computed on 20 percent of the first $10,000 of tuition paid per family. If you have three people in your family in higher education beyond the undergraduate years, for example, you would add their tuition expenses together to figure out the credit.
The Internal Revenue Service does not allow taxpayers to comingle the two credits per student. However, if you have multiple students in college at the same time, you could spread the credits among them—say, the American Opportunity Tax Credit for your son the sophomore business major, and the Lifetime Learning Credit for your daughter the sixth-year pharmacy student.
Eligibility for both credits begins to phase out as incomes climb into the higher ranges. But a higher-income taxpayer can take as itemized deductions the cost of tuition if it applies to him or her as an individual obtaining a basic skill or enhancing skills to maintain an existing job.
Other provisions also allow you to reduce the cost of higher education:
• Once you graduate and start working, you can deduct interest paid on a student loan up to a maximum of $2,500 per year.
• If an employer pays your tuition, that is considered compensation and part of your income. Uncle Sam allows you to exclude up to $5,250 of tuition paid by an employer on your behalf per year.
• You can receive a break through tax-preferred education savings plans such as Coverdell and 529 plans: Whatever you contribute, you can exclude from income. Much like a pension account, the earnings on the saving plan are not taxable, and the distributions are not taxable if they’re for tuition or related expenses.
All this methods can reduce the price tag of a higher education. But knowing that the government will help you pay for it? Priceless.
Chuck Williams is dean of the College of Business at Butler University. William Terando, Associate Professor of Accounting at the COB, contributed to this article. For more information on the College and its “real life, real business” approach to business education, visit www.ButlerRealBusiness or e-mail Chuck at email@example.com.
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