Most people have heard of the student loan interest deduction. You may not be aware that there are many tax breaks available for student loans and tuition.
Federal income tax benefits are available for college savings through 529 college savings plans and Coverdell Education Savings Accounts. Some states also offer state income tax credits or deductions based on 529 plan contributions.

College is becoming more expensive each year. You can reduce the cost of your post-secondary education by taking advantage as many tax credits as possible for student loans and tuition. These are the deductions and credits that you need to be aware.

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC), which is partially refundable, provides a tax credit based upon college tuition, fees, and course materials. Required textbooks, equipment, and supplies are all part of course materials.

The AOTC can be worth up to $2,500 per student. It represents 100% of the first $2,000 of qualified expenses and 25% for the second $2,000. The AOTC can be partially refunded up to $1,000 (40%) and 25% of the second $2,000.

The AOTC can be claimed by taxpayers for up to four years of postsecondary education, and a maximum of four tax years per student. It can also be claimed for expenses incurred during the first three months and subsequent tax years.

The student must be enrolled at least half-time in a college or university that qualifies for Title IV federal student aid to qualify for the AOTC. The student must also be working towards a college certificate or degree.

The AOTC phase out at $80,000 to $90,00000 for single taxpayers, and $160,000 to $180,000 if married taxpayers file a joint return. Individual taxpayers who file their tax returns separately as married taxpayers are not eligible.

Lifetime Learning Tax Credit

The Lifetime Learning Tax Credit (LLTC), which is a non-refundable credit that can be used to pay tax, up to $2,000 per taxpayer. It is based on 20% tuition fees, required textbooks, supplies, and equipment, and based upon the first $10,000 of tuition. The tax credit is for the taxpayer only, not the student.

The LLTC has many advantages over the AOTC. It can be claimed for unlimited. The student does not have to pursue a degree, so the LLTC may be used for continuing education.

The income phaseouts for LLTC, however, are a little lower than those for the AOTC. It will be phased out with a modified adjusted Gross Income (MAGI), of $59,000 to $69,000 for single filers, and $118,000 - $138,000 for married filers filing jointly.

Qualified Scholarships

If the student is pursuing a degree, scholarships that pay tuition, fees, and course-related materials (e.g. books, supplies, and equipment), are exempt from tax.

However, amounts used to cover living expenses such as transport and room and board are taxable. On their federal income tax returns, the student must include the taxable portion of any scholarships they have received.

FICA taxes are not applicable to qualified scholarships. Qualified scholarships are exempt from FICA taxes if they are not subject to income phaseout. This can make it one the most valuable tax breaks available for student loans and tuition.

Education Assistance for Employer-Paid

A taxpayer may exclude up to $5,250 of employer-paid education assistance from their income. The following expenses are eligible: tuition, fees, supplies, equipment, and student loan repayment.

This benefit is available to all students, regardless of their degree. The eligible courses include continuing, graduate, and undergraduate education, as well employer-provided courses. The employee must take the courses, and not their spouses or dependents.

Employer-paid education assistance is not subject to income phaseout. However, it may not be discriminatory against highly-paid employees. Owners or shareholders with more than 5% ownership of the business are limited in the amount of assistance they may receive.

Deduction of student loan interest

The Student Loan Interest Deduction allows you to exclude from your income up to $2,500 of interest on federal student loans and private student loans. Even if the taxpayer doesn't itemize deductions on his federal income tax return, it can still be claimed.

The student loan interest deduction phased out at $70,000 to $85,000 single taxpayers, and $145,000 to $175,000 married taxpayers who file joint returns. Ineligible taxpayers who file separate tax returns are those who file them as married. These income phaseouts apply to 2022 and are adjusted each year for inflation.

Tuition Gift Tax Exclusion

Section 2503(e), of the Internal Revenue Code of 1986 exempts tuition paid directly to educational institutions from gift taxes. This tax exemption is only for tuition. Other college expenses, such as tuition, fees, room and board, or transportation are not eligible.

This benefit is seldom needed as the annual gift tax exemption is usually sufficient. In 2022, the annual gift tax exclusion for recipients is $16,000 per giver. A married couple could gift up to $32,000 per year to each grandchild in order to pay college costs or for other purposes. You can make contributions up to five times your annual gift tax exclusion amount through a 529 plan with five-year gift-tax average.

The tuition gift exclusion does not have an income phaseout. However, some colleges may consider such gifts to be a resource and reduce eligibility for need-based financial assistance on a dollar per dollar basis.

Plans for College Savings

After-tax dollars are used to make college savings plans such as 529 plans and prepaid tuition plans. When used to pay for eligible higher education expenses, earnings accumulate tax-deferred and are completely tax-free.

Tuition, fees, books and supplies are all eligible expenses for higher education. If the student is only enrolled for half-time, room and board are a qualified expense. Transport is not considered a qualified expense.

529 Plans

For 529 plans, student loan repayments up to $10,000 are eligible expenses. This is a lifetime limit. Each beneficiary and each beneficiary's sibling are eligible for $10,000 in student loan repayment.

Two-thirds of states offer a state income credit or deduction based on contributions to their 529 plan. These seven states offer it for contributions to any state’s 529 plan. The state income tax break is available in all but four states, even if the taxpayer receives a distribution the next day. The state income tax break is based on the contributions net of distributions.

Other than the gift tax exclusion limit, annual contributions are not limited to 529 plans. 529 plans permit five-year gift tax exemptions, also known "superfunding", which allows lump sum contributions to exceed the annual gift-tax exclusion. Each state has its own contribution limit. They range from $235,000 up to $542,000. 529 plans do not have income phaseouts.

Check out our complete guide to 529 plans and locate your state to find out what it offers.

Coverdell Education Savings accounts

Coverdell Education Savings Accounts' (ESAs), are restricted to $2,000 per annum from all sources until age 18. Income phaseouts are available for single filers, which range from $95,000 to $100,000 and $190,000. to $220,000 for married couples filing jointly. These income phaseouts don't adjust for inflation.

Savings Bonds

The interest paid on Series EE U.S. saving bonds issued in 1990 and subsequent year, as well as all Series I U.S. Saves bonds, is exempt from income if it is used to pay tuition or fees. Rollovers into a 529 plan and prepaid tuition plans, or Coverdell Education savings account are exempt from income.

Income phaseouts are available for $85,800 to $100,000.00 (single) or $128.650 to $158,650 for married filing jointly. Separate filing by married couples is not eligible. These income phaseouts apply to 2022 and are adjusted each year for inflation.

Student Loan Forgiveness

Through December 31, 2025, student loan forgiveness and discharges will be exempt from tax. There is a good chance that this exclusion could be extended or made permanent.

Public Service Loan Forgiveness, along with a number of other programs, would continue to be tax-free even if the overarching benefit is lost. Other types of loan cancellations, such as those that are due to death or disability, and forgiveness after an income-driven repayment plan have the potential to be taxable.

Last Thoughts

The IRS does not allow double-dipping. Taxpayers cannot claim two tax breaks for tuition or student loans on the basis of the same qualified expenses due to coordination restrictions. Only one tax break can be claimed for every dollar of qualified expenses.

The American Opportunity Tax Credit pays more per $1 for qualified expenses than the Lifetime Learn Tax Credit, Qualified Scholarships, and 529 plan distributions. If a taxpayer is eligible to both the AOTC or the LLTC, they should choose AOTC because it is more valuable.

To qualify for the maximum American Opportunity Tax Credit, taxpayers should budget $4,000 for textbook and tuition expenses. To maximize the AOTC's qualified expenses, they could consider a portion or all of a scholarship taxable.

Additional information on tax breaks for student loans and tuition can be found in IRS Publication 970, Tax Benefits for Education. Publication 920 is usually updated in January or February each year.