Education is expensive. Those of you paying, or planning to pay, tuition know that is a truism. It costs a lot to prepare for occupations that require higher levels of education, yet a quality education typically pays for itself with a lifetime of earnings that greatly exceed the costs.
To help with these costs the United States Government has extended several tax breaks to help qualifying individuals and families reduce the cost of education, by providing a subsidy through the tax system. For 2012, the American Opportunity Tax Credit and the Lifetime Learning Credit continue to exist, following being extended in 2010 for continuance through 2012. What are they?
The Lifetime Learning Credit provides a $2,000 tax credit per return, if one or more students are enrolled in one or more courses at a qualified educational institution. The tax credit is designed for those with incomes below statutory limits. Single filers begin to lose this tax credit when their Adjusted Gross Income (AGI) reaches $50,000 and it disappears completely at an AGI of $60,000. Married tax payers begin to have their Lifetime Learning Credit phased out at an AGI of $100,000, becoming completely exhausted at an AGI of $120,000.
The American Opportunity Tax Credit provides a maximum tax credit of $2,500 per student per tax year for the first four years of higher education expenses. It is fully available to single taxpayers with an AGI of under $80,000 and is phased out to zero when their AGI reaches $90,000. For married taxpayers, the credit begins to disappear at an AGI of $160,000, becoming zero at an AGI of $180,000. A nice characteristic of the American Opportunity Tax Credit is that tax filers that do not owe federal income taxes are still eligible to receive up to 40% of the credit, or $1,000, as a refundable tax credit.
If you claim either tax credit, you are unable to take an “above-the-line” tax deduction, also known as an adjustment to income used to calculate Adjusted Gross Income. The education deduction allows one to claim up to a $4,000 deduction, if the taxpayer’s Adjusted Gross Income is not greater than $65,000 for a single filer or $130,000 for joint filers. This allowable deduction reduces to $2,000 for single-filers with Adjusted Gross Income of $80,000, or $160,000 for joint filers.
Let’s assume you are single with an Adjusted Gross Income of $30,000 and, thus, in the 15% marginal tax bracket, implying you would pay $0.15 in taxes on the next dollar you earn. While a $4,000 deduction sounds larger than a $2,500 tax credit, it would only reduce your taxes by $600 (=$4,000 * .15). On the other hand, a tax credit reduces your taxes dollar for dollar. If you are single and claim the American Opportunity Tax Credit, the $4,000 in educational expenses would allow you to take a $2,500 tax credit. Thus you have reduced your taxes by $2,500, which is 4.17 times greater than if you had taken the “above-the-line”, $4,000 tax deduction. To repeat: A tax credit reduces your taxes dollar for dollar, while a tax deduction reduces your taxes by the amount of the deduction times your marginal tax rate.
Additional tax breaks for students do exist. Student loan interest up to $2,500 is tax deductible. Teacher classroom expenses are deductible up to $250 for teachers. Moreover, if your employer provides educational benefits, up to $5,250 in employer provided education assistance is not included in calculating your income.
If you have young children and you believe that education is correlated with financial success, Coverdell Educational Savings accounts and state 529 plans allow for tax-free contributions to college savings plans, assuming that the money is eventually used for higher education expenses. These can be a very efficient way to reduce taxes, while saving money for college and a great way to commit to your human capital or that of your descendants.
For more information on the Missouri 529 plan, see https://missourimost.s.upromise.com/ .
More information on taxes may be found at http://www.cch.com/wbot2012/017Education.asp .
If you live in central Missouri and qualify for free Volunteer Income Tax Assistance, consider having our trained preparers help you. Click for locations and hours.