Tax Breaks To Help Defray College Costs

If you have children headed for college or already there, you don't need a financial adviser to know how much it costs.

But, thanks to several tax breaks, you can get help paying for it — and you might benefit from a little advice from The Early Show money maven Ray Martinon what those tax breaks are and how to claim them.

Hope Scholarship and Lifetime Learning Tax Credits

The Hope Scholarship is a tax credit that can equal up to $1,650 per qualifying student, per year. It's based on a simple formula: 100 percent of the first $1,100 of a college student's annual tuition and fees, excluding room and board costs, plus 50 percent of the next $1,100. There is a catch: This credit can be claimed for only two tax years per student. It's not available for students who are in their third or later years of college. Also, the credit is allowed only when the student is enrolled at least half-time for at least one academic period beginning in the year the credit is claimed.


On The Early Show Thursday, Martin discussed legislation passed by the House of Representatives that would trim interest rates on many student loans. He also addressed college costs and how to get the funds to pay them, including using the tax breaks discussed in this column. To watch that segment, .

The Lifetime Learning credit is available for students after the first two years of school, when the Hope credit is no longer allowed. The Lifetime Learning credit is available for all years of postsecondary education and for courses to acquire or improve job skills. Also, unlike the Hope credit, the Lifetime credit is available for an unlimited number of years and isn't subject to half-time enrollment requirements. The credit equals 20 percent of tuition and fees (up to $10,000), for a maximum annual credit of $2,000.

Other stipulations for both credits are:

  • You must file a federal tax return, owe taxes — and you must claim the eligible student as a dependent on the tax return. Of course, the credit is for the taxpayer or the taxpayer's spouse, too.
  • The full amount of the credits is available for single taxpayers whose modified adjusted gross income (AGI) is less than $47,000, and is gradually reduced to zero for income up to $57,000. For joint filers, the full credits are available when income is below $94,000, and is gradually reduced to zero for modified AGI up to $114,000.
  • No Double Dipping: These credits cannot be claimed for expenses paid with earnings from a Section 529 plan or withdrawals from a Coverdell Education Savings Account. Also, you can't claim the credits in the same year you claim deductions for college tuition for the same student.

    Planning Tip: To apply for these credits, you will need to report the amount of tuition and fees paid, as well as the amount of scholarships, grants, and untaxed income used to pay the tuition and fees. Schools send this information each year by January 31 via a form 1098-T to individual taxpayers and the IRS.

    How to claim these credits: Use this information and your own records of tuition and fees paid to complete IRS Form 8863 to claim the tax credit. The form 1098-T sent by the school should also include contact information for someone at the school who can answer questions about the information on the form.


    Tuition and Fees Deduction

    For 2007, you can deduct up to $4,000 of higher tuition and fees paid for you, your spouse, or any other person you can claim as a dependent on your tax return. This is an "above-the-line" deduction, which means you don't have to itemize in order to take advantage of the break. However, the $4,000 figure is the annual maximum, regardless of how many students may be in your family.

    The other stipulations are:

  • The full deduction is available for single taxpayers whose modified AGI is less than $65,000 and is gradually reduced to zero for income up to $80,000. For joint filers, the full deduction is available when income is below $130,000 and is gradually reduced to zero for modified AGI up to $160,000.
  • You're cannot claim this deduction at all if you're married and file separately from your spouse.
  • No deduction is allowed on the tax return of any person who can be claimed as a dependent on another's return. So, your dependent college-age child can't claim the deduction on his or her own return when your own AGI is too high to qualify.
  • No Double Dipping: No deduction can be claimed for expenses paid with earnings from a Section 529 plan or withdrawals from a Coverdell Education Savings Account. Also, you can't claim the deduction in the same year you claim the Hope Scholarship or Lifetime Learning tax credit for the same student.

    Planning Tip: This deduction is popular with families who have income at levels too high to qualify for the Hope and Lifetime Learning credits. This is an above-the-line deduction, so taxpayers don't have to itemize to claim it.

  • How to Claim this deduction: The Tax Relief and Health Care Act of 2006, which was signed into law on Dec. 20, kept this tax break from expiring. Since this law was passed after the IRS printed its forms and instructions for 2006 returns, you won't find a line for this deduction on Form 1040 or Schedule A. Some of the printed IRS instructions may even say this deduction is no longer available. For 2006, to claim the higher-education tuition and fees deduction, you'll need to go to line 35, and write the letter "T" after the number "35" and before the words "Domestic production activities deduction…" That is a dual-purpose line where taxpayers can also claim another type of deduction.


    Student Loan Interest

    If you pay interest on student loans and you qualify, you can deduct up to $2,500 of annual college loan interest charges. This can include the interest on student loans for you, your spouse, or anyone you can claim as a dependent. This can also include interest on loans that have been refinanced and consolidated.

    The full deduction is available for single taxpayers whose modified AGI is less than $55,000 and is gradually reduced to zero for income up to $70,000. For joint filers, the full deduction is available when income is below $110,000 and is gradually reduced for modified AGI up to $140,000.


    Tax-Free Employer Education Reimbursements

    Some employers reimburse you for tuition you pay for classes you take. According to the tax regulations, up to $5,250 of the amount reimbursed is income tax-free. Even graduate-level courses qualify for tax-free employer reimbursements.

    This break is available only for costs incurred by you, the employee. So, outlays for your kids or spouse to take college classes are ineligible. One great feature is that there's no AGI-based phase-out rule for this benefit.

    Planning Tip: If you are the owner of a business, consider establishing a tuition reimbursement plan, which can be especially valuable if you employ members of your family who are enrolled in college.


    College Costs and Taxes

    Many families who otherwise qualify for tax credits and tax deductions get tripped up when they spend money on tuition and fees for education. Remember that the IRS prohibits "double dipping," or claiming tax credits or deductions for the same education expenses that are paid for with tax-free withdrawals or exempt interest from college savings investments or accounts (such as 529 accounts, Education Savings Bonds, Coverdell Education Savings Accounts).

    Planning Tip: If you qualify for the tax credits or deductions, they are almost always more valuable for the average taxpayer. Make sure to use enough money from a taxable account (mutual fund, savings account, custodial account — not a 529 or Coverdell account) toward these expenses to qualify for the credits or deductions.

    • Brian Dakss

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