Education Tax Break Mistakes to Avoid

(Reuters) – Uncle Sam is willing, even eager, to help you offset higher education costs with tax breaks.

However, getting the biggest benefit isn’t easy since the available deductions and credits come with a welter of different and often-confusing rules.

Plus, most of the tax breaks are mutually exclusive – if you use one, you often can’t use another.

There are plenty of ways families get it wrong, said education-funding consultant Deborah Fox of San Diego’s Fox College Funding. Even the certified public accountants that Fox teaches at workshops are surprised to learn some of the intricacies of education tax benefits.

Here are some of the main ways you can blow it:


Currently there are two credits and one deduction for education expenses: the American Opportunity Credit, the Lifetime Learning Credit and the tuition and fees deduction, said Lisa Greene-Lewis, CPA for TurboTax, a division of Intuit Inc.

You have to pick one, since they’re mutually exclusive when used on the same student in the same year. You also can’t take any of those breaks on expenses you paid with a tax-free withdrawal from your 529 college savings plan.

Planning ahead can ensure you’re able to take full advantage of your available tax breaks, Fox said. The American Opportunity Credit, for example, can only be used for tuition, fees and course materials, while the 529 can be used for any qualified education expense.

“You might use the 529 to pay for housing and use other funds to pay tuition and fees” to qualify for the credit, Fox said.


For those who qualify, the American Opportunity Credit is typically the one to choose first. It can reduce your taxes by up to $2,500, offsetting 100 percent of the first $2,000 in qualified higher education expenses plus 25 percent of the second $2,000.

Furthermore, 40 percent of the credit, or up to $1,000, may be refundable, which means you’d get cash back if your tax bill is too low to use up all the credit.

Still, there are several restrictions on taking the credit.

It’s available only if the student is enrolled at least half-time in a program that leads to a degree or certificate and only for four years of study per student.

The credit phases out for singles with modified adjusted gross income (MAGI) between $80,000 and $90,000 and for married couples filing jointly with MAGI between $160,000 to $180,000.

Those who don’t qualify for the American Opportunity Credit may be able to take the Lifetime Learning Credit, which is limited to $2,000 per tax return for those with modified gross incomes under $63,000 if single, or $127,000 if married and filing jointly. Students don’t need to pursue a degree to qualify and it’s available for all years of postsecondary education and job training.

Finally, there’s the tuition and fees deduction, which expired at the end of last year, but which can still be used on education expenses paid in 2013 (including for academic periods that began in 2013 and extended into this year, or that began in the first three months of 2014).

It can reduce your income by up to $4,000 and is available to single taxpayers with MAGI under $80,000 and married taxpayers filing jointly under $160,000.

The Internal Revenue Service and TurboTax both have free, interactive tax assistants that can help you decide which breaks you can use.


It’s usually true that credits are worth more, since they directly reduce your tax bill dollar for dollar.

The value of deductions, on the other hand, varies by your tax bracket. A $4,000 deduction would be worth just $600 to someone in the 15-percent federal tax bracket, for example, or $1,584 to someone in the 39.6-percent bracket.

The tuition and fees deduction is, however, an “above the line” tax break, which means it reduces your adjusted gross income.

Since AGI is used for financial aid purposes, those who are getting need-based financial aid mostly in the form of scholarships or grants (rather than loans) could wind up ahead of the game by taking the deduction instead of a credit, Fox said.

“If 75 percent of your need-based aid is scholarships, you’ll get 75 cents extra on every extra dollar you can reduce your AGI,” Fox said.

“The combination of the deduction plus the extra scholarship funds could end up adding up to more than claiming the credit. The tax software doesn’t take financial aid into account so this is not on the radar screen of most tax preparers.”


At the other end of the economic spectrum, some parents have too much income to claim the education tax credits, but their children probably could qualify, Fox said.

This takes some number-crunching, since the parents have to give up claiming the child as a dependent and make sure the child can pay enough of the education bills to qualify for the credit. (That also rules out this maneuver for most students getting need-based aid, since student-owned assets count heavily against them in financial aid formulas.)

For high-earning families, though, letting the student take the credit “can work quite well,” Fox said.