If you incurred educational expenses during the year, you may be able to take the advantage of that at tax time by using the American Opportunity Tax Credit, the Lifetime Learning Tax Credit or the Tuition and Fees Deduction. The educational tax credits offer a bigger tax break to students and parents, but are harder to qualify for. The tuition and fees deduction also offers a savings, but parents can't claim expenses they pay on behalf of their children.
A taxpayer can take only one of the three educational tax breaks in any given year.
American Opportunity Tax Credit
Of all the tax breaks for education, the American Opportunity Tax Credit offers the largest possible tax benefit. The credit refunds qualified educational expenses dollar-for-dollar, up to $2,500 per student. The credit is 40 percent refundable, which means that you can get a partial refund even if you don't owe any income tax for the year. For example, if you qualify for the full $2,500 and you don't owe any tax, the IRS will refund you $1,000 of the credit -- 40 percent of $2,500.
Although the American Opportunity Tax Credit is the most generous, there's a limit to how long you can claim it. Taxpayers can claim the credit for four tax years per eligible student. Once the student completes four years of post-secondary education, the taxpayer no longer is eligible for the credit. Only taxpayers with a modified adjusted gross income less than $90,000 - or $180,000 for married couples -- can claim the credit.
Lifetime Learning Credit
If you've already claimed the American Opportunity Tax Credit for four years, the Lifetime Learning Credit offers the next-best tax benefit. Unlike the American Opportunity Tax Credit, the Lifetime Learning Credit is not refundable. However, it does offer a direct tax reduction dollar-for-dollar, up to $2,000, for each student. You don't need to be pursuing a degree to claim the credit and there's no limit to how many years you can claim it.
Unfortunately, the Lifetime Learning Credit isn't available to higher-income taxpayers. Only single taxpayers with a modified gross income under $64,000 and married couples with a modified gross income under $128,000 can claim the credit. Taxpayers who want to claim either credit can do so on Form 8863.
Tuition and Fees Deduction
If you don't qualify for either of the tax credits, the Tuition and Fees Deduction also can save you money. Taxpayers can deduct up to $4,000 of eligible educational expenses. You can claim the credit only for yourself or a spouse - in other words, a parent can't claim it on behalf of a child. A deduction reduces your taxable income, not your tax liability, so the tax break usually isn't as good. For example, if you're in the 33 percent income tax bracket and you deduct $4,000, your tax is only reduced by $1,320 ($4,000 multiplied by 33 percent).
The Tuition and Fees Deduction is available for single taxpayers with a modified adjusted gross income under $80,000 and married taxpayers with a modified adjusted gross income under $160,000. There's no limit to how many times a taxpayer can claim this credit.