Take Advantage of Education Tax Credits

It's time again for the dreaded annual exercise of filing tax returns and financial aid forms. But I offer encouraging news for many taxpayers faced with college tuition bills and other related expenses. Buried in the year-end extension of the Bush-era income tax cuts was the far less publicized renewal of educational tax benefits. For taxpayers who meet the income qualifications, these benefits provide some welcome tax relief and should not be overlooked as you begin to prepare your 2010 tax return. Eligible taxpayers who pay qualified educational expenses will want to take advantage of either the American Opportunity Credit, a tax credit of up to $2,500, or of the $4,000 Tuition and Fee Deduction, depending upon which provides the greater savings given one’s particular tax rate and circumstances.

The American Opportunity Credit, which was recently extended through 2012, will permit taxpayers who pay qualified tuition and related expenses to claim a credit against their federal taxes of up to $2,500 per year per student. Here’s how it works: Taxpayers can reduce their tax liability dollar for dollar for the first $2,000 of qualified expenses, plus take an additional 25% on the next $2,000. If you have a tax credit which exceeds your actual tax liability such that you cannot use some or all the benefit, you are eligible to receive up to 40% of the amount of the tax credit, or a maximum of $1,000. As long as your income is $160,000 or less for married couples and $80,000 for single taxpayers, you can take advantage of the maximum credit. The credit is ratably reduced for higher income levels and fully phased out at $180,000/$90,000. In order to take advantage of the credit, married couples must file jointly. A parent claiming the credit must also be the person paying the expenses for the eligible student, which can be oneself, a spouse, or a dependent, provided no one else has claimed the student as an exemption.

Families might find that, depending on their tax rate, it is more beneficial to take the $4,000 tuition tax deduction. The deduction is a direct adjustment to income and can be claimed even if one does not itemize expenses for tax filing purposes. Many of the qualifications are the same as those for the American Opportunity Credit, including income levels and the joint filing requirement for married couples. Unlike the tax credit, the deduction is per taxpayer and is not calculated on a per student basis. Therefore the tax credit is likely to be more favorable than the deduction for families with multiple students in college.

Taxpayers who paid interest on education loans can also deduct up to $2,500 in interest expense, thereby reducing the amount of income subject to taxes in the year the interest was paid. As with the other benefits, proceeds of the loan must have been used for qualified educational expenses. Furthermore, the taxpayer must be the borrower on the loan. Income limits to take advantage of this deduction are $70,000 and $145,000, for single and married individuals, respectively.

If someone in your family, yourself included, was a college student in 2010 and/or you paid student loan interest, don't lose out on the opportunity to take advantage of these tax benefits. Consult a tax specialist to ensure that you receive the maximum benefit available to you.