You can offset the costs of higher education with two credits: the Lifetime Learning credit and the American Opportunity tax credit. The Lifetime Learning credit provides for a broader range of learners than the American Opportunity tax credit, since the American Opportunity tax credit is only available for the first four years of postsecondary education. Full-time or part-time students in undergraduate, graduate, professional, or continuing education programs at a higher education institution may use the Lifetime Learning credit.
The Lifetime Learning credit provides a nonrefundable credit equal to 20% of up to $10,000 of qualified expenses you pay. This credit is per taxpayer return, not per student like the American Opportunity tax credit.
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Qualified expenses include tuition and fees necessary for the enrollment or attendance of you, your spouse, or any of your dependents at a higher education institution. Expenses do not include books, sports fees (unless they are part of the degree program), activity fees, insurance expenses, transportation costs, or room and board. You must reduce your qualified expenses by scholarships, grants, and other tax-free educational benefits, but you do not need to reduce your qualified expenses by gifts, bequests, or inheritances. Higher education institutions include accredited postsecondary educational institutions that offer degree programs and are eligible to participate in student financial aid programs, i.e., colleges, community colleges, and many vocational schools.
There are limitations on using the Lifetime Learning credit. First, the credit is phased out if you are single with adjusted gross income (AGI) between $55,000 and $65,000 or married filing jointly with AGI between $111,000 and $131,000 ($110,000 and $130,000 for 2015). These amounts may be adjusted annually for inflation.
Second, if you are married filing separately, you cannot claim either the Lifetime Learning credit or the American Opportunity tax credit.
Third, you may elect either the American Opportunity tax credit or the Lifetime Learning credit with respect to one student. However, if you have more than one student at the same time, you can use the American Opportunity tax credit to offset the expenses of one student and the Lifetime Learning credit to offset the expenses of the other student. You may claim the American Opportunity tax credit or the Lifetime Learning credit for some educational expenses and use tax-free Coverdell Education Savings Account earnings for educational expenses for which no credit is taken.
NOTE: The effective rate of the Lifetime Learning Credit is 20%. If you are in the 25% tax rate bracket or higher, you may receive a greater tax benefit by claiming your education expenses as a business deduction on Schedule C or an employee business expense on Schedule A, if applicable to you. Education expenses you deduct as employee business expenses are subject to the 2% floor. Because of the credit phase-outs, self-employment tax, and miscellaneous itemized deduction limitations, you must decide the best way for you.
You may claim a Lifetime Learning credit of $200 (20% x $1,000 for the tuition). The $980 of books, room, travel, and meals do not qualify for the credit. However, if you are an employee who itemizes deductions, in addition to the credit of $200, you can deduct $200 (($100 books + 300 room + 380 travel + 100 (200 x 50%) deductible meals) – 680 (34,000 AGI x 2%)) giving you an additional $30 ($200 x 15%) of tax savings.
If you are self-employed, your total tax rate on your business income is 30.3% (15% income tax rate plus 15.3% self-employment tax rate). Rather than claiming the credit, you could deduct the education as a business deduction. Your tax savings from the deduction would be $570 (($1,000 tuition + 100 books + 300 room + 380 travel + 100 (200 x 50%) deductible meals) x 30.3% total tax rate).
Julie Welch (Runtz) is the owner of Meara Welch Browne. She graduated from William Jewell College with a BS in Accounting and obtained a Masters in Taxation from the University of Missouri- Kansas City. She serves as a discussion leader for the AICPA National Tax Education Program. She is co-author of 101 Tax Saving Ideas.