With approximately 19.9 million students expected to attend American colleges and universities in the fall of 2018, parents must be thinking about how tuition costs are going to be met. While the largest source of funding comes from loans via financial aid, tax breaks also play a significant role.
There are three primary tax breaks for education expenses: the American Opportunity Tax Credit, the Lifetime Education Credit, and the Tuition and Fees Deduction. The Tuition and Fees Deduction was retroactively enacted earlier in 2018 for tax year 2017, but is currently expired for 2018 tax returns. This annual uncertainty is a common theme with the deduction, as it has been set to expire every year and Congress keeps renewing it at the last minute, but there is no guarantee that it will continue to be in effect for future tax years.
The American Opportunity Tax Credit (AOTC)
The AOTC, formerly known as the Hope Credit, currently provides up to $2,500 of direct tax credits to help alleviate the cost of higher education. The first $2,000 of qualified higher education expenses are eligible for 100% reimbursement in credits, and the next $2,000 can generate an additional 25%, for a total of $2,500 in credits for the first $4,000 of education expenses.
The credit is only available for the first four years of a student’s college education, and the student needs to carry at least half of a full course load. In addition, the student needs to be enrolled in a program that leads to a degree or credential.
Income limits apply for those attempting to claim the credit. For 2018, taxpayers filing jointly are phased out when adjusted income is between $160,000 and $180,000. Single taxpayers are phased out of claiming the credit when adjusted income is between $80,000 and $90,000. Taxpayers who don’t pay federal income tax as a result of very low earnings are eligible to receive up to 40% of the credit as a refundable tax credit.
The Lifetime Learning Credit
The Lifetime Learning Credit is worth up to $2,000 per year, crediting 20% of the first $10,000 of qualified higher education expenses. Unlike the AOTC, the Lifetime Learning Credit isn’t restricted by number of years and the student does not need to be pursuing a degree program. Also, there is no full-time course load requirement. The credit can be used even if only one class is being taken.
Like the AOTC, there are some income limitations, but they are lower. For 2018, married taxpayers filing jointly are phased out starting at $114,000 and credits are eliminated once adjusted income reaches $134,000. The range for single taxpayers is $57,000-$67,000. Also, the credit is limited to $2,000 per calendar year, while the AOTC is limited per student.
Putting It All Together
Unfortunately, the tax credits can’t be used for the same student’s expenses in the same year, so you’ll have to choose one or the other. As a general rule of thumb, the AOTC will give the highest benefit to most taxpayers. The next one to look to is the Lifetime Learning Credit, and for taxpayers who are phased out of education credits due to higher incomes, they should look to the Tuition and Fees Deduction. As with everything tax and finance related, there are always exceptions, so consult with your Certified Financial Planner™ and tax professional to ensure you’re making the best choices.
Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.