Federal Tax Benefits

Federal Tax Benefits

In addition to financial aid, students and their families have access to several federal tax benefits that help lower their college expenses.

HOPE Scholarship Tax

The HOPE Scholarship program helps make the first two years of college or career school more affordable by providing up to $1,500 as a non-refundable tax credit. Students receive a 100 percent tax credit for the first $1,200 of tuition and required fees and a 50 percent credit on the second $1,200. This credit is available for tuition and required fees less grants, scholarships and other tax-free educational assistance.

This credit is phased out for filers above a certain income threshold. These limits are adjusted each year for inflation. Check with your financial aid office for the current rate. The credit can be claimed in two years for students who are in their first two years of college or career school and who are enrolled on at least a half-time basis in a degree or certificate program for any portion of the year. The taxpayer can claim a credit for his or her own tuition expense or for the expenses of his or her spouse or dependent children. Students must be enrolled at least half-time for at least one academic period and must be pursuing an undergraduate or other recognized educational credential. This credit can be claimed for more than one family member since there is no limit on the amount available to be claimed in any one year.

Lifetime Learning Tax Credit

This tax credit is targeted at adults who want to go back to school, change careers, or take a course or two to upgrade their skills and to college juniors, seniors and graduate and professional degree students. A family will receive a 20 percent tax credit for the first $10,000 of tuition and required fees paid each year for a maximum non-refundable tax credit of $2,000. Just like the HOPE Scholarship tax credit, the Lifetime Learning tax credit is available for tuition and required fees less grants, scholarships and other tax-free educational assistance. The maximum credit is determined on a per-taxpayer (family) basis, regardless of the number of postsecondary students in the family, and is phased out at the same income levels as the HOPE Scholarship tax credit. Families will be able to claim the Lifetime Learning tax credit for some members of their family and the HOPE Scholarship tax credit for others who qualify in the same year. An eligible taxpayer must file a tax return and owe taxes to claim the credit. The taxpayer must also claim the eligible student as a dependent unless the credit is for the taxpayer or the taxpayer's spouse. Students are not required to pursue a degree or other recognized educational credential and can enroll for as few as one course. The maximum amount that can be claimed in any year is $2,000.

Student Loan Interest Deduction

Those who have paid interest on a student loan may be eligible to deduct some interest paid on qualified student loans. To qualify, the loan must have been taken out solely to pay qualified educational expenses and cannot be from a related person or made under a qualified employer program. This program phases out for single taxpayers with incomes between $50,000 and $65,000, and joint filers with incomes between $100,000 and $130,000.

Individual Retirement Accounts/Coverdell Education Savings Accounts

Since January 1, 1998, taxpayers have been able to withdraw funds from an IRA without penalty for their own higher education expenses or those of their spouses or children, or even their grandchildren. In addition, for each child under age 18 families may deposit $2,000 per year into an education IRA in the child's name. Earnings in the education IRA will accumulate tax-free, and no taxes are due upon withdrawal if the money is used to pay for postsecondary tuition and required fees (less grants, scholarships and other tax-free educational assistance), books, equipment, and eligible room and board expenses. Once the child reaches age 30, his or her education IRA must be closed or transferred to a younger member of the family.

A taxpayer's ability to contribute to an education IRA is phased out when the taxpayer is a joint filer with an adjusted gross income between $190,000 and $220,000 or a single filer with an adjusted gross income between $95,000 and $110,000.

State Tuition Plans/Qualified Tuition Programs (QTPS)

Effective January 2002, withdrawals taken for qualified educational expenses from 529 plans are free from federal income tax through 2010 when a family uses a qualified state-sponsored tuition plan to save for college. Families can now use these plans to save not only for tuition but also for certain room and board expenses for students who attend college on at least a half-time basis. Tuition and required fees paid with withdrawals from a qualified state tuition plan are eligible for the HOPE Scholarship tax credit and Lifetime Learning tax credit. These benefits became available on January 1, 1998. These programs and other prepayment programs (529 plans) are currently undergoing significant changes. Many states are taking a careful look at how these programs can be modified to ensure their long-term viability. Check with the state agency that is offering the plan for further information.

Going to School While You Work

Section 127 of the federal tax code allows workers to exclude up to $5,250 of employer-provided education benefits from their income. For courses beginning after January 1, 2002, the payments may be for either undergraduate or graduate-level courses. The payments do not have to be for work-related courses. Expenses include tuition, fees, books, equipment and supplies. Workers may be able to deduct some of the costs related to education as a business expense. This provision enables many Americans to pursue their goals of lifelong learning.

Community Service Loan Forgiveness

This provision excludes from income tax student loan amounts forgiven by nonprofit, tax-exempt charitable or educational institutions for borrowers who take community-service jobs that address unmet community needs. For example, a recent graduate who takes a low-paying job in a rural school will not owe any additional income tax if in recognition of this service his or her college or another charity forgives a loan it made to him or her to help pay for college costs. This provision applies to loans forgiven after August 5, 1997.

The AMERICORPS program also offers a number of attractive options to either help finance a college education or pay back federal student loans for students who dedicate a few years to community service. For additional information, call 800-942-2677 or visit their web site at http://www.americorps.org/. For information on additional student aid programs that will help meet the costs of college and lifelong learning, call 800-4FED-AID.

Early IRA Distributions

Students can take distributions from their IRAs for qualified educational expenses without having to pay the 10 percent additional tax for an early distribution. They may owe income tax on at least part of the amount distributed, but they may not have to pay the 10 percent additional tax. The part not subject to the additional tax is generally the amount of the distribution that is not more than the adjusted qualified expenses for the year. See IRS Publication 970 for more information.

Educational Savings Bond Program

Students may be able to cash in qualified U.S. savings bonds without having to include in their income some or all of the interest earned on the bonds. A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in the student's name or in the name of both the student and his or her spouse. The owner must be at least 24 years old before the bond's issue date. The issue date is printed on the front of the savings bond. See IRS Publication 970 for more information.