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A quick lesson on 8 education tax breaks

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Public schools in my part of Austin will welcome students on Aug. 16. Yeah, that's next week. Many universities also will begin classes this month.

That leaves a small window now for some school-related tax lessons. So here's a crash course on eight educational tax breaks.

Some help cover kindergarten through high school graduation costs. Others apply only to higher education expenses. There's even some federal tax help for post-graduation folks looking to improve their work skills.

Let's start with two popular tax credits, since they offer dollar-for-dollar tax savings.

American Opportunity Tax Credit: The AOTC, as it's known in tax acronymese, can be claimed by people enrolled in college courses. It's worth up to $2,500 credit per eligible student. This is calculated as 100 percent of the first $2,000 spent on qualifying education expenses, plus 25 percent of the next $2,000 spent for qualifying college costs. The AOTC is partially refundable, meaning under certain circumstances part of the credit (up to $1,000) can be returned to eligible taxpayers as a refund.

Expenses that qualify for the AOTC include tuition and certain related expenses required for enrollment or attendance at the student's college.

Lifetime Learning Tax Credit: This education tax credit, known as the LLC, also can be claimed in connection with students currently enrolled in college. The LLC is worth up to $2,000 credit per federal tax return, not per student. That amount is calculated as 20 percent of the first $10,000 in tuition expenses paid per year. The LLC is not refundable, meaning that it can reduce your tax bill to zero dollars, but any credit that exceeds your tax liability is lost.

But, as the name indicates, the LLC is available to a wider range of students. This includes those in graduate school, as well as individuals who are not in school, but take courses to acquire or improve job skills.

My post last year on comparing education tax credits has more on the income limits and other requirements for claiming the AOTC or LLC.

Student Loan Interest Tax Deduction: The depth of debt into which many students and their families find themselves in order to pay for college is a continuing, and controversial, conversation. The Biden Administration is still looking into ways to eliminate at least some college loan obligations. However, if you're still paying for school loans, be sure to take advantage of the tax deduction for some of the interest on your student loan.

Technically, this tax break is one of the two dozen income adjustments still referred to as above-the-line deductions.

This deduction is a maximum of $2,500 of student loan interest paid each year. The deduction could be reduced if your earnings exceed a certain amount. You also must have taken out the loan solely to pay qualified education expenses for you, your spouse, or a dependent. But the good news is that you don't have to itemize to claim this tax deduction.

These two tax credits and one quasi-deduction can help after you've paid college or other educational expenses. However, the tax code also offers benefits when you are saving for future class costs. Here are two such tax-favored school savings programs.

529 Plans: Created by Congress in 1996, these accounts officially are designated as a "qualified tuition program" in the Internal Revenue Code (IRC). However, they are more commonly referred to by the IRC section 529 that covers their associated tax benefits.

There are two types of 529 plans, a tuition prepayment plan, and a savings (really an investment) plan to which you contribute money to be used later to pay for a student's qualified higher education costs. The tax-favored savings plan option is the more popular choice, and is the one that typically is referred to in 529 plan discussions.

The tax benefits for a 529 savings plan include account growth that is federally tax-deferred, letting your money compound more quickly since you don't lose a portion of it to taxes. That tax benefit extends to 529 withdrawals; as long as you use the money to pay for qualified education expenses, Uncle Sam won't collect a dime. Also, in some instances 529 funds can be used to pay for non-college educational costs.

Contributions to 529 plans, which are state-sponsored and offered in every state and District of Columbia, aren't deductible on your federal tax return. However, most states that tax residents' income offer state tax deductions on 529 plan contributions or tax exemptions on withdrawals.

Read more on these tax-advantaged higher education savings plans in my post 529 college saving plan perks and pitfalls. The recently enacted retirement law known as Secure 2.0 also makes some changes to 529 plans, notably on how unused amounts can be shifted to a Roth IRA.

Coverdell Education Savings Accounts: A Coverdell education savings account, or ESA, is another tax-favored way to save for college. Like 529 plans, Coverdell money grows tax free, and distributions to pay for qualified college expenses are tax free, whether incurred at a public, private, or religious school. You also can use the money to pay qualified kindergarten through college costs. The biggest downside of a Coverdell is its relatively small $2,000 per child maximum annual account contribution limit.

In addition, there are a couple of other valuable, though less common, tax-favored ways to pay educational costs. Here are three.

Employer-Provided Educational Assistance: Many companies offer their employees generous job benefits. In some cases, that includes employer-provided education assistance. These funds, up to a $5,250 maximum, are provided to workers to help cover educational costs. The money is a tax-free benefit, since it is excluded from worker's taxable income.

If you get financial assistance from your firm, it will be noted on the W-2 form your employer issues you and copies to the IRS. And if your employer is very generous with this benefit and you get more than the tax-free limit, you'll have to pay tax on the benefit amount that exceeds $5,250.

Savings Bonds: Yes, many consider savings bonds an archaic way to stash cash. However, these government issued financial instruments also can help pay for some higher education costs for yourself, your spouse, or a dependent. Interest earned on eligible Series EE issued after 1989 and I bonds is not taxed as long as the bond owner uses the redeemed bonds to pay qualified higher education expenses at an eligible institution. In addition to meeting certain requirements, there's also an income limit for the education-related savings bond interest exclusion.

Early IRA Distributions: It's usually not a good idea to raid your retirement savings. However, if you need traditional IRA money to pay qualified higher education expenses, you can get a bit of tax relief.

When you take money from a traditional IRA before you celebrate your 59½ birthday, you must pay a 10 percent tax penalty on the distribution. However, when the money is used for certain school-related costs, the penalty is waived. You must, though, still pay tax on the IRA amount you withdraw.

Education expenses that qualify for the 10 percent penalty waiver include tuition and fees, and books, supplies, and equipment required for enrollment or attendance. Students attending at least on a half-time basis can also use penalty-free IRA money to pay room and board. Special needs students can avoid the penalty if the expenses are for any special services incurred in connection with the student's enrollment or attendance.

As noted, the educational expense tax breaks involve a variety of eligibility requirements and many are subject to other limitations. Some can be combined, while others preclude such dual tax claims. And the IRS never allows double-dipping, which is using the same expenses to claim different tax breaks. That's why it's

So if you're a student of the parent of one and need help paying school costs — and who doesn't nowadays? — it's a good idea to seek some tutoring from a tax professional familiar with the Internal Revenue Code's educational breaks.

Taking another educational ride (UPDATE, Aug. 15, 2023): Earworm warning! My latest tumblr post at Tumbling Taxes in connection with education tax breaks includes a video of Wheels on the Bus.  

You also might find these items of interest:

 

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