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The ABCs of federal tax breaks for college education expenses

You can save as much as $2,500 per student, but how much you claim depends on your income, the student's educational status and how and when you paid the bill.

March 01, 2009|Kathy M. Kristof

If you're paying for a college education, you may need an advanced degree to figure out how to claim federal tax breaks for those expenses.

Congress in recent years has approved myriad special credits, deductions and other tax breaks for people paying tuition bills and related costs, and new breaks and twists were added in the recent stimulus bill.

The tax breaks can be generous, saving you as much as $2,500 per student. But how much you can claim depends on your income, the student's educational status and how and when you paid the bill.

"We call it complexification," said Jackie Perlman, an analyst at H&R Block's Tax Institute in Kansas City, Mo. "We hear people saying that they would like the tax law simplified, but simplifying means eliminating tax breaks. It's really simple when there's nothing to claim."

There's no worry of anything simple when it comes to college costs. Among the education-related breaks for 2008 are two tax credits, two deductions and at least two significant "income exclusions." And for 2009 there's a new and improved tax credit.

Tax credits provide a dollar-for-dollar reduction in the tax you owe. Deductions reduce the income that's subject to tax. Income exclusions, like deductions, reduce the amount of income that's subject to tax.

By and large, education tax breaks are mutually exclusive: If you take one, you can't claim another for the same child. But if you have more than one child in college, you generally get to choose the best tax break for each student's expenses.

Also, you can lose your ability to claim most of these breaks if your income is too high.

Here's a rundown on what's available for 2008 (with the exception of the American Opportunity credit, which applies to expenses paid in 2009 and 2010):

Hope credit

If you are paying the tuition of a freshman or sophomore enrolled at least half-time in college, you can claim a Hope tax credit of as much as $1,800.

You calculate it by multiplying 100% by the first $1,200 in tuition costs paid and 50% by the next $1,200 in tuition expenses.

If your adjusted gross income exceeds $48,000 on an individual return or $96,000 on a joint return, you can claim only part of the credit. The credit disappears entirely once your income tops $58,000 for an individual or $116,000 for a couple.

There's usually no credit for paying for room, board, books or fees. There's also no credit if the student has been convicted of a felony.

Lifetime Learning credit

This break applies to juniors, seniors, graduate students and even people taking a few classes in their free time. This credit equals 20% of tuition expenses and is capped at $2,000.

The income thresholds to claim the Lifetime Learning credit are the same as those for the Hope credit.

Tuition and fees deduction

You can deduct from taxable income the amount you paid in tuition and fees in 2008, up to $4,000. This deduction is claimed on the front of Form 1040; in other words, you can claim it even if you don't itemize your deductions.

The income limits are less restrictive than those on the Hope and Lifetime Learning credits: The deduction is phased out if your adjusted gross income exceeds $65,000 for an individual or $130,000 for a couple. It's gone entirely if your income exceeds $80,000 for an individual or $160,000 for a couple.

College savings withdrawals

If you take money out of a 529 plan -- a state-sponsored college savings vehicle -- to pay eligible college bills, no part of the withdrawal is taxable, not even the previously untaxed investment earnings that have accumulated in the account.

This exclusion applies no matter how much you withdraw, and there are no income restrictions. But you can't claim the Hope or Lifetime Learning credit or the education deduction for expenses paid by a tax-free withdrawal from a 529 plan.

Beware: If you withdraw money from a 529 plan but don't use it for qualified education expenses, the investment earnings are not only taxable but also subject to a tax penalty.

Employer-paid expenses

If your employer pays for your college tuition, books or fees, $5,250 of the amount paid is not taxable.

American Opportunity credit

For college expenses in 2009 and 2010, the Hope credit is replaced by the American Opportunity Tax Credit, which provides more money -- as much as $2,500 per student -- and is available to more people.

Income limits don't kick in until your adjusted gross income exceeds $80,000 for an individual or $160,000 for a couple.

The credit is completely phased out once individual income tops $90,000 or joint income surpasses $180,000.


Kathy Kristof is a personal-finance author and syndicated columnist.

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