Don't Mess With Taxes

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May typically is the end of high school for millions of students across the United States. After a summer break, a lot of these new graduates will be heading off to college.

In addition to the new classroom challenges, these students and their families will face the daunting task of paying for college.

Uncle Sam can help a bit.

Be they freshmen or returning to university studies, the Internal Revenue Code has a couple of tax breaks, the American Opportunity and Lifetime Learning tax credits, that could help cover some of students’ common college costs.

Here’s a quick primer on the tax credits, starting with a key component they share. As tax credits, they are among the best types of tax savings, since credits offset dollar-for-dollar any tax you owe.

Now to the specifics of each educational credit.

American Opportunity Tax Credit: The AOTC, as it's known in tax acronymese, can be worth a maximum benefit of up to $2,500 per eligible student.

The AOTC is available only available for costs related to pursuing a degree or other recognized education credential.

It also only applies to qualifying expenses during the student’s first four years at a post-secondary or vocational school. Those eligible costs are tuition and certain related expenses required for enrollment or attendance at the selected school, including necessary course materials.

The AOTC’s exact credit amount 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 also is a partially refundable credit. So, if under certain circumstances the AOTC reduces students’ tax liability to zero, they could receive up to $1,000 of excess credit as a refund.

Lifetime Learning Tax Credit: This education tax credit, known as the LLC, also can be claimed in connection with students currently enrolled in college. But it’s also available, as the name implies, for studies beyond the first four years at a university.

The LLC can be claimed by graduate students for their additional studies’ tuition and fees, as well as by individuals who are not in school, but are taking courses to acquire or improve job skills.

Like the AOTC, the exact LLC tax credit amount is calculated as a percentage of costs. For the LLC, that’s 20 percent of the first $10,000 in tuition expenses paid per year, up to a maximum credit of $2,000.

Unlike the AOTC, the credit amount is set per return, not student. And no part of the LLC is refundable. If your LLC amount is more than your tax bill, you lose the excess credit.

Income limits apply: Both the AOTC and LLC impose income limits on taxpayers, based on modified adjusted gross income (MAGI) for the tax year. MAGI is your adjusted gross income (AGI), with some of the credits and adjustments that got you to your AGI added back in.

There’s an earnings limit on the ability to claim either of the educational credits. The credit amounts also are phased out as earnings increase.

You can claim the full $2,000 LLC or $2,500 AOTC for both tax years 2024 (if you got an extension to file) and 2025 if you are single with a MAGI of up to $80,000 or married filing jointly with a MAGI of up to $160,000.

The phaseout threshold for the credits is between $80,000 and $90,000 for single taxpayers. It’s between $160,000 and $180,000 for married couples who file a joint return. When your income is more that the top phaseout amount for your tax status, you cannot claim the AOTC or LLC.

You can use the IRS’ online Interactive Tax Assistant tool to check out your eligibility, or that of your parents if they’re covering your schooling costs, for either of these credits.

IRS paperwork: Finally, if you can claim the AOTC or LLC, your educational institution should send you early in the tax year a Form 1098-T. This document, also known as the Tuition Statement, is sent to students who paid qualified tuition and related expenses during the tax year.

Information on the 1098-T will be entered on Form 8863, which you’ll file to claim either the American Opportunity or Lifetime Learning credit.

Okay, enough tax credit lessons. Congratulations on your graduation. Have a great summer break before heading back to school, hopefully with some payment help from Uncle Sam.

You also might find these items of interest:

• A quick lesson on 8 education tax breaks
• 7 financial gifts, some with tax benefits, for graduates
• Tax filing reminder for student athletes: NIL income is taxable

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