Higher Education Costs: How To Get The Best Tax Treatment
College costs are among the largest expenses a family faces, and the tax code offers several ways to ease the burden. The best result usually comes from coordinating those benefits rather than claiming the first one you find.
Education credits
Federal law provides tax credits for qualified education expenses paid for yourself, your spouse or a dependent. A credit reduces your tax directly, which makes it more valuable than a deduction of the same amount. The main credits differ in how many years they can be claimed, whether they apply to undergraduate or graduate study, and whether any part is refundable. Both phase out at higher incomes, and you generally cannot claim more than one credit for the same student in the same year.
Tax-advantaged savings accounts
529 plans allow earnings to grow tax-deferred and to come out tax-free when used for qualified education expenses. Other education savings accounts exist with their own contribution and income limits. Withdrawals used for anything other than qualified expenses may be taxed and penalized on the earnings, so match withdrawals to actual bills.
Avoid double benefits
The same dollar of expense generally cannot be used for both a tax-free withdrawal and a credit. For example, if you claim a credit for tuition, you usually cannot also treat that same tuition as paid from a tax-free savings withdrawal. Careful records of which expenses were paid from which source prevent errors and potential IRS questions.
Student loan interest
Interest paid on qualified student loans may be deductible even if you do not itemize, subject to income limits. The deduction is available to the person legally obligated on the loan, which can include parents who borrowed for a child's education.
Who claims the student?
When a child is your dependent, you generally claim the education credit, even if the child paid the bills with their own money. Whether your child can also claim certain benefits depends on the dependency rules. Because a student's own return can affect yours, it helps to decide this before filing.
Scholarships and employer help
Scholarships used for tuition and required course materials are generally tax-free, but amounts applied to room and board or other costs may be taxable. Employer education assistance can also be tax-free up to limits set by the IRS.
Plan before the bills arrive
The timing of payments can matter, since credits are tied to the year in which expenses are paid. A short planning session before each semester can often save real money.
If college is on the horizon, our tax planning team can review your options. You can also contact us to schedule a conversation.
This article is general information, not tax, legal or investment advice for your specific situation.