Back to basics: Education tax benefits help taxpayers pay for college
Tax benefits for students can help families pay and save for college.
The 2017 Tax Cuts and Jobs Act (TCJA) modifies and suspends some of the benefits for students, people who are saving for college, and people who are paying off their student loans. However, many of the most popular tax benefits for education, like education credits and the student loan interest deduction, remain unchanged.
Tax benefits for students who attend college
The American Opportunity Credit (AOC)
The American Opportunity Credit is a credit of up to $2,500 per eligible student. Up to $1,000 of the credit is refundable. It is only available for four tax years per student and is only available if the student has not completed the first four years of postsecondary education before the beginning of the tax year. Eligible students must be enrolled at least half-time for at least one academic period and must be pursuing a program leading to a degree or other recognized credential.
The AOC is generally claimed by the parents of undergraduate students. Students may need to work together with their parents to determine the amount of eligible education expenses to claim the credit and make sure their parents have copies of Form 1098-T, receipts for expenses and the account transcript. The AOC generally doesn’t help graduate students or students who work full-time and take a class at night to develop their skills or finish a degree.
To claim the AOC, use Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits).
Tax law prevents taxpayers from double dipping on education benefits. That means an individual can’t claim the AOC or Lifetime Learning Credit for expenses paid with a nontaxable scholarship. However, sometimes a taxpayer benefits by treating nontaxable scholarship income as taxable and claiming the AOC. This is most likely to be beneficial if the student has very little other income and the student’s parents can claim a full AOC.
The Lifetime Learning Credit
The Lifetime Learning Credit is a credit of up to $2,000 for qualified education expenses paid for all eligible students included on the taxpayer’s tax return. There is no limit on the number of years the Lifetime Learning Credit can be claimed, and the student does not have to enroll in a minimum number of hours to claim the credit.
Graduate students, undergraduate students enrolled less than half-time, and students who work full-time and take a class or two to develop skills or finish a degree generally claim the Lifetime Learning Credit. Because the Lifetime Learning Credit is smaller than the AOC, students who qualify for both credits generally choose the AOC.
To claim the Lifetime Learning Credit, use Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits).
Nontaxable scholarships and grants
Under current law, scholarships and grants required to be used for tuition and fees remain nontaxable when used to pay tuition and fees. Scholarships that can be used to pay any expense (such as room and board) are nontaxable when spent on qualified expenses and taxable when spent on nonqualified expenses.
For this purpose, qualified expenses include:
- Tuition and fees required to enroll at or attend an eligible educational institution, and
- Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students.
Qualified education expenses do not include the cost of:
- Room and board,
- Clerical help, or
- Equipment and other expenses that aren't required for enrollment in or attendance at an eligible educational institution.
Additionally, amounts received as payment for services such as teaching, research, or clerical help are generally included in gross income and cannot be excluded as a scholarship.
In any other case, scholarships or grants provided in exchange for services are taxable.
Qualified tuition reduction programs
Taxpayers who receive benefits through a qualified tuition reduction program can also treat their benefits as nontaxable. These programs, generally for undergraduate studies only, are often offered by colleges to their employees and benefits may be extended to the spouses and dependents of employees.
Many students in grad school who are teaching or assisting in research also receive tuition reductions. A tuition reduction you receive for graduate education is qualified, and therefore tax free, if both of the following requirements are met:
- It is provided by an eligible educational institution.
- The recipient is a graduate student who performs teaching or research activities for the educational institution.
Education exception to early distribution penalty for IRAs
In some circumstances, taxpayers may take a distribution from an IRA before reaching age 59½ and not have to pay the 10 percent additional tax on early withdrawals. The exception to the 10 percent additional tax applies if, for the year of the distribution, the taxpayer pays qualified education expenses for:
- The taxpayer,
- The taxpayer’s spouse, or
- The taxpayer or spouse's child, foster child, adopted child, or descendant of any of them.
Distributions from traditional IRAs are generally fully taxable in the year the distribution is made. That’s because taxpayers often do not have any basis in their traditional IRA and the entire distribution is taxable. Taxpayers with some basis in an IRA will generally have a partly taxable distribution. Distributions from Roth IRAs are generally not subject to income tax.
Education savings bond exclusion
Taxpayers who cash in certain savings bonds under an education savings bond program can exclude the interest from income.
To exclude interest from savings bonds used for education, the bond must have been issued to an individual who was at least 24 years of age before the month the bond was purchased. For example, if a parent buys a savings bond for their child and puts the bond in the child’s name, in order to qualify for exclusion, the child must be 24 years old before the month the bond was purchased. Another option would be for the parents to put the bond in their own name, assuming they are at least 24 years old.
Additionally, the educational expenses must be for the taxpayer, spouse or a dependent in the year the expenses were paid, and the bonds were cashed.
Employer-provided educational assistance
The employer-provided education assistance exclusion allows employers to offer up to $5,250 per year in educational assistance as a tax-free benefit.
Employees who receive this type of assistance work with their human resources department to make sure they meet the program requirements and can receive nontaxable benefits. Taxable benefits are sometimes paid out (for example, if an employer pays more than the allowable yearly limit, the excess is taxable). The value of any taxable benefits is reported in Box 1 of Form W-2 along with other types of compensation.
Some forms of education could also potentially be considered a working condition fringe benefit; these types of benefits are usually excludable as well.
Tax benefits for those with student loan debt
Student loan interest deduction
The student loan interest deduction is an adjustment that allows taxpayers to reduce their taxable income by up to $2,500. It is based on the amount of qualified student loan interest paid during the year. That’s interest paid on a loan that the taxpayer was obligated to pay. The loan must have been taken out solely to pay for qualified education expenses for a qualified student. One key requirement is that the student must be the taxpayer, spouse or a dependent in the year the loan was taken out. The student must have been enrolled at least half-time in a program leading to a degree, certificate, or other recognized credential at an eligible institution.
The student loan deduction has an income-based phaseout, and a small percentage of people do not qualify for the deduction because of the phaseout. Taxpayers who refinance their student loans generally may continue to claim the deduction.
Student loan repayment assistance
The TCJA left in place rules that allowed certain student loan repayment assistance made on behalf of taxpayers to be tax-free in some circumstances.
Loan repayment assistance is nontaxable if received for any of the following:
- The National Health Service Corps (NHSC) Loan Repayment Program (NHSC Loan Repayment Program).
- A state education loan repayment program eligible for funds under the Public Health Service Act.
- Any other state loan repayment or loan forgiveness program that is intended to provide for the increased availability of health services in underserved or health professional shortage areas (as determined by such state).
Exclusion for canceled student loan debt
For more details, see “Exclusion for certain canceled student loan debt remains intact with new possible exclusions.”
Tax benefits to help save for college
529 Education Savings Plans
For more details, see “More 529 Plan distributions are tax-free.”
Coverdell Education Savings Accounts (Coverdell ESAs)
Contributions to Coverdell ESAs aren’t deductible but amounts deposited in the account can grow tax free until distributed. There is a $2,000 annual contribution limit to all accounts per beneficiary, and the ability to contribute is phased out when income exceeds the phaseout limit.
When distributions from a Coverdell ESA during the year are less than the beneficiary’s qualified education expenses, distributions are tax free. Distributions can be used for elementary, secondary, and higher education expenses.
H&R Block tax professionals, click to login to the Tax Research Center:
- Education Tax Benefits Quick Reference Card (QRC)
- Category: Education
- What should a tax professional consider when reviewing a taxpayer’s Form 1098-T?
- What education benefits are available for tax purposes?
- What are qualifying education expenses (QEEs)?
- May a taxpayer use more than one education benefit in the same tax year?