Students are back in school. For some parents, their students are off to college. While April 2022 seems a long way away, now is the time to determine if you will qualify for tax benefits for your child’s higher education expenses. By making the determination now, you can make sure that you have the documentation you will need to claim tax benefits when you file your 2021 return. The following provides a brief explanation of the tax benefits available.

EXCLUSIONS

Some educational assistance benefits are excluded from income. As a result, no income tax is paid on these benefits. However, the educational expenses paid with the tax-free benefits cannot be used as the basis for educational deductions or credits. The educational benefits which may be excluded from income are:

• Up to $5,250 per year of benefits received from your employer under an educational assistance program. These benefits should not be reported in the recipient’s W-2. These payments may be for undergraduate or graduate studies, but payments cannot be for room and board, transportation, tools and supplies or courses involving sports, games or hobbies unless required by a degree program.
  

• Scholarships and grants if:

-The amount received does not exceed the qualified education expenses,

-The student is a candidate for a degree at an eligible institution,

-The funds are not earmarked for another purpose (such as room and board) and -The funds are not payment for services required to be performed as a condition  of the grant or scholarship.

Qualified expenses include tuition, fees and course-related expenses, such as books, supplies, and equipment that are required for all students in the course.

• Distributions from a qualified tuition program (529 plans) so long as the distribution does not exceed the qualified education expenses. Qualified expenses include required tuition and fees, books, supplies and equipment including computer or peripheral equipment, computer software and internet access and related services if used primarily by the student enrolled at an eligible education institution. Room and board may also qualify.

• Distributions from Coverdell Education Savings Account are tax free if distribution does not exceed qualified education expenses. Distributions can be used not only for college education expenses, but also elementary and secondary school. Qualified education expenses include tuition and fees, required books, supplies and equipment and room and board. If the distribution exceeds qualified education expenses, a portion will be taxable to the beneficiary and will usually be subject to an additional 10% tax. Additional rules regarding Coverdell accounts are beyond the scope of this newsletter.

• Fullbright scholarships, Pell Grants, and other need-based grants are treated like scholarships and are not taxable if the rules regarding scholarships are satisfied.

• Educational benefits under any law administered by the Department of Veterans Affairs (VA) are tax free.

• Qualified tuition reduction benefits and graduate education benefits may or may not be taxable. The rules are more complicated and beyond the scope of this article.
  

DEDUCTIONS

• The Taxpayer Certainty and Disaster Tax Relief Act of 2020 repealed the tuition and fees deduction for tax years beginning after 2020.

• Interest paid on a qualified student loan, up to a maximum of $2,500, is deductible. The deduction can be claimed whether or not deductions are itemized on the return. In order to be eligible to claim the deduction:

-The taxpayer’s modified adjusted gross income must be below annually set  limits,

-The taxpayer must not be eligible to be claimed as a dependent on another’s  return,

-The taxpayer must not have a married filing separately status and

-The taxpayer must be legally responsible for paying the loan interest.

CREDITS

Credits reduce a taxpayer’s income tax liability dollar-for-dollar for qualified expenses paid. There are two credits available for higher education expenses. These are:

American Opportunity Credit

• The amount of the credit is $2500 per student,
• 40% of the credit is refundable,
• The modified adjusted gross income of the taxpayer claiming the credit must be below annually set limits,
• The eligible student is the taxpayer, the taxpayer’s spouse or a dependent listed on the tax return,
• The taxpayer claiming the credit cannot have a married filing separately status,
• The taxpayer claiming the credit must not be eligible to be claimed as a dependent on another’s return,
• The spouse of the taxpayer claiming the credit cannot be a non-resident alien, unless the spouse elects to be treated as a resident alien on the return,
• The credit is only available if the student has not completed 4 years of post-secondary education,
• The student must be pursuing a degree or other recognized education credential,
• The student must be enrolled at least half time for at least one academic period,
• The student must have no felony drug convictions,
• The credit applies only to qualified expenses which are defined as tuition, required enrollment fees and course materials needed for the course of study and
• The qualified expenses can be paid by the taxpayer claiming the credit, the taxpayer’s spouse, the student or a third party.
  

Lifetime Learning Credit 

• The amount of the credit is $2000 per student,
• The credit is non-refundable,
• The modified adjusted gross income of the taxpayer claiming the credit must be below annually set limits,
• The eligible student is the taxpayer, the taxpayer’s spouse or a dependent listed on the tax return,
• The taxpayer claiming the credit cannot have a married filing separately status,
• The taxpayer claiming the credit must not be eligible to be claimed as a dependent on another’s return,
• The spouse of the taxpayer claiming the credit cannot be a non-resident alien, unless the spouse elects to be treated as a resident alien on the return,
• The credit is available for all years of post-secondary education and for courses to acquire or improve job skills,
• The student does not need to be pursuing a degree or other recognized education credential,
• The credit is available for one or more courses,
• The credit applies only to qualified expenses which are defined as tuition, and fees required for enrollment and
• The qualified expenses can be paid by the taxpayer claiming the credit, the taxpayer’s spouse, the student or a third party.

To help you prepare your return, your student will receive a Form 1098-T from the educational institution by January 31. This form reports to the IRS the amount of qualified educational expenses received from the student. The form will also report the amount of any scholarships and grants received by the student. However, the form will most likely not include other eligible expenses such as books and other course required material. As noted above, there are some educational programs that allow its funds to be used for room and board, computers and other educational expenses. These expenses will not be reported on the Form 1098-T.

If interest was paid during the year on a student loan, the lender will issue a Form 1098-E reporting that interest payment to the IRS. However, this form will only be issue if the interest paid was $600 or more. If less interest was paid during the year, then you will have to obtain documentation which shows how much interest was paid to the lender during the year so that the interest can be deducted on the return.

As you can see, the forms which you will receive from lenders and educational institutions may only be part of the information you will need to prepare your return. Gathering all documentation of expenses incurred by your student during the year, may result in significant tax savings to you. The time to start gathering these documents is now.