tax rewards for your college spending

There are numerous tax credits and tax benefits to help families manage the cost of higher education. Here is an overview of some of the programs available.

Hope Credit
A tax credit reduces the amount of income tax a family has to pay. With the Hope Tax Credit, some parents can reduce their federal taxes by up to $1,800 per college student ($3,600 if a student is in a Midwestern disaster area). The new American Opportunity Credit has replaced the Hope Credit for most taxpayers. For 2009, you can claim a Hope Credit only if at least one eligible student is attending an eligible educational institution in a Midwestern disaster area and you do not claim an American Opportunity Credit for any other student in the same year. There are income requirements to obtain the credit. These income requirements vary year to year due to inflation. Please refer to IRS Publication 970 to get income requirements for the current year. Other Hope Credit provisions include:

• Available only until the first 2 years of post-secondary education are completed.
• Student must be pursuing an undergraduate degree or other recognized education credential.
• Student must be enrolled at least half time for at least one academic period beginning during the year.
• No felony drug conviction on student's record.
• Can't apply the same expenses to both the Hope credit and the Lifetime Learning Credit.

American Opportunity Credit
The American Opportunity Credit provides a maximum allowable credit of $2,500 per eligible student for four years of post-secondary education. This credit modifies the existing Hope Credit for tax years 2009 and 2010, making it available to a broader range of taxpayers. Income guidelines are expanded and required course materials are added to the list of qualified expenses. Please refer to IRS Publication 970 to get income requirements for the current year. American Opportunity Credit provisions include:

• Available only for the first 4 years of postsecondary education. 
• Available only for 4 tax years per eligible student (including any year(s) Hope Credit was claimed).
• Student must be pursuing an undergraduate degree or other recognized education credential.
• Student must be enrolled at least half time for at least one academic period that begins during the tax year.
• No felony drug convictions on student's record.

Lifetime Learning Credit
Up to $2,000 can be claimed as the Lifetime Learning Credit ($4,000 if a student is in a Midwestern disaster area). This credit is computed as 20% of the first $10,000 paid in tuition and eligible class fees. Room and board, transportation, etc. are not covered. Differing from the Hope Credit, the Lifetime Learning Credit is calculated per taxpayer, not per college student. This means that the maximum credit a taxpayer may claim for a taxable year is $2,000 (unless in Midwestern disaster area), no matter how many students are in the household. The income requirements for the Lifetime Learning Credit are the same as for the Hope Credit. The Lifetime Learning Credit differs from the Hope Credit in that it is:

• Available for all years of postsecondary education and for courses to acquire or improve job skills.
• Available for an unlimited number of years.
• Available for one or more courses.
• Not denied due to a student's felony drug conviction.

Student Loan Interest Deduction
Taxpayers who have taken loans to finance an education at an eligible institution (a university, college, vocational school, or other post-secondary school that is qualified to participate in federal student aid programs) may be qualified to deduct interest they pay on loans for themselves, their spouse or dependent. The maximum deductible amount of interest is $2,500. This tax credit also has income limitations, which vary year to year due to inflation (refer to IRS Publication 970). Terms of this program include:

• Student loan must have been taken out solely to pay qualified education expenses, including tuition, fees, room and board, books, supplies, transportation, and other necessary expenses.
• Loan cannot be from a related person or made under a qualified employer plan.
• Student must be enrolled at least half-time in a degree program.

Coverdell Education Savings Account
The Coverdell Education Savings Account lets families invest up to $2,000 per child per year. Contributions to a Coverdell account are not deductible, but amounts deposited in the account grow tax free until distributed. If distributions from an account are not more than the beneficiary's qualified education expenses, the withdrawals are tax-free. These accounts have income limits (refer to IRS Publication 970). Contribution provisions to these accounts include:

• No contributions other than cash can be made to a Coverdell account.
• No contributions can be made to a Coverdell account after the beneficiary reaches age 18, unless he is a special needs beneficiary.

Qualified Tuition Program (aka 529 Plan)
Certain states and educational institutions allow taxpayers to prepay or contribute to a tuition savings account on behalf of a student. No tax is due on a distribution from a 529 plan unless the amount distributed is greater than the beneficiary's adjusted qualified education expenses. There are no income restrictions on the individual contributors. Other terms and features include:

• Annual contributions of more than $13,000 ($24,000 if contributing with a spouse) are subject to the gift tax.
• Each state determines its own lifetime contribution limit.
• If money is taken out of a 529 plan for purposes other than education, the parents will be charged a 10 percent penalty on the earnings and have to pay federal taxes on the earnings.
• Contributions can be made to both a Coverdell account and a 529 plan for the same beneficiary in the same year.

For information on other programs that have tax benefits or for more specific information on the programs listed above, please refer to IRS Publication 970. If you have any questions about the programs, please consult a tax professional.

Information gathered from www.irs.gov.
Posted: 1/3/2006
Updated: 4/05/2010