Karla Dennis, EA, MST & CEO of The Award Winning Tax Accounting Firm Karla Dennis and Associates Inc. — Specializing In Tax Planning
To the average parent and college student in the U.S., the cost of higher education is extremely high, albeit generally beneficial to ensure future generations of workers have the necessary skills. According to College Board, in 2018-2019, the total average cost for higher education at a four-year, in-state, public university in the U.S. was $21,370. With education costs being as high as they are, there are ways in which parents, as well as adults going back to school, can get education-related deductions on their federal tax returns.
American Opportunity Tax Credit
If you owe the IRS $100, and you have a tax credit of $100, that tax credit will wipe out your tax bill by $100. That’s how tax credits work.
Now let’s talk about the two most popular education-related tax credits and why you should love the way tax credits work with regard to education. The first is the American opportunity tax credit. It provides a tax credit of 100% of the first $2,000 you pay in qualified education-related expenses. So if you paid $2,000 for tuition, fees and class materials, you can get a tax credit on your individual 1040 return and immediately wipe out $2,000 worth of taxes owed. The American opportunity tax credit also allows you a credit of 25% of the next $2,000 in qualified expenses.
The benefit of this credit is you can get up to $2,500 as a tax credit. Not only that but it is also 40% refundable. This means if you have a $2,500 tax credit and your tax liability is only $2,000, you can be refunded for $500. This refundable credit is a great part of the American opportunity tax credit, but this isn’t the only educational tax credit available.
The Lifetime Learning Credit
With the lifetime learning credit, you don’t necessarily have to be in a higher education scenario. You can be going back to school or continuing your education; however, you don’t necessarily need to be in a degree program. You can use this credit for undergraduate studies, graduate studies or if you just want to make sure you are staying on top of your employment field. This particular credit allows you to get up to $2,000 (i.e., you can get a credit of 20% of up to $10,000 of your education expenses) and is popular for people who are not in a traditional educational program. In addition to the two tax credit options, you have some additional deductions at your disposal through the tax code.
In the tax code, some savings plans will allow you to save for college for your children in a tax-advantaged way. These are called 529 plans.
However, in most cases, the saving plans are not deductible on your federal return. Some states will allow you to deduct your savings for your kid’s college toward your state income tax return, but that decision is made on a state-by-state basis.
The Coverdell Education Savings Account (ESA)
Formerly known as an “Education IRA,” this can also be a good option for new parents and families who are looking to save for their children’s education. The best part about the Coverdell ESA is parents can use it to pay for elementary or secondary expenses in addition to higher education. Through this ESA, you can save up to $2,000 per year for your kid up to the age of 18. This savings account will allow you to put aside money that will grow tax-free. If you start now, you can pull that money out when it is time for your kid to go to college.
As a parent, you always want to look out for your children and your wallet. You could potentially save thousands in taxes if you take advantage of the tax credits and savings accounts that are at your disposal. Speak to a licensed tax professional if you are looking to put your kids through college so that you can maximize your tax savings.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.