As per the IRS law, there are several deductions, tax credits and savings plans which are available to the taxpayers who seek to acquire higher education. A deduction is nothing but a reduction from the amount of your gross income on which tax is payable. Due to this, your overall tax liability will come down. Tax credit is a kind of rebate. It is reduction from the amount of tax which you need to pay. Tax-saving savings plans are those which allow the accumulated interest to grow tax free. This holds true till the money is withdrawn (distribution). In some cases, even the distribution is tax free. Moreover, there are certain incomes which are exempted from tax, which mean, they need to be disclosed but would not be considered as ‘income’ which is liable to tax. Such incomes are also called as exclusions.
Let us discuss each one of this in a step by step manner
(i) Tuition Fees: Any education expense in the form of tuition fees paid during the year for yourself, your spouse or your dependent can be claimed as deduction from your income. However, you cannot claim this deduction if another person is claiming an exemption for you as a dependent on his tax return. The deduction is available only for higher education. You cannot claim this deduction under the following circumstances:
1. Your filing status is married filing separately
2. Your MAGI (Modified Adjusted Gross Income) is more than $80,000 ($1,60,000 if filing a joint return)
3. If another person is claiming an exemption on the same amount as a dependent
4. Your residential status is that of a non-resident alien
(ii) Student Loan Interest Deduction
If the MAGI is less than $75,000 ($1,50,000 in case of a joint return), you will enjoy a special deduction for paying interest on a education loan used for higher education. This is the interest which you pay on a qualified student’s loan. The interest payments include mandatory as well as voluntary payments of interest. It may be noted that you can claim this deduction even if you have not itemized deduction on Form 1040’s Schedule A.
(B) Tax Credits
(i) American Opportunity Credit
The Hope Credit, which was applicable till 2008 have been modified for tax years 2009, 2010, 2011 and 2012 and is called as American Opportunity Credit. This scheme includes wide range of tax payers and includes people with high incomes who are not liable to pay tax. This credit is applicable to course materials also and allows the credit to be claimed for four post-secondary years instead of two.
(ii) Hope Credit
This was applicable in the year 2008 and all the earlier years. This has not been modified into American Opportunity Credit,
(iii) Lifetime learning Credit
This is useful for post-secondary education. You can claim a tax credit up to $2,000 for the education expenses which are qualified. There is no time limit on the number of years up to which the students can claim the credit. However one must remember that the tax payer cannot claim American Opportunity Credit and the Lifetime learning Credit for the same student in the same year.
(C) Tax-saving Plans
(i) Coverdell Education Saving Account
A Coverdell Plan can be used to pay a student’s eligible k-12 expenses as well as post-secondary expenses. The total contributions for the beneficiary of this account cannot exceed $2,000 in a year. It must be remembered that the contributions to the Coverdell account are not deductible but the account grow tax-free until distributed. The beneficiary need not pay any tax on the distributions if they do not exceed his qualified education expenses. However, if the qualified expenses fall short of the overall distribution, that portion will be taxable in the hands of the beneficiary. Moreover, 10% additional tax will be levied. The beneficiary need not pay the additional tax if there is death, disability or if he obtains a qualified scholarship.
(ii) 529 Plans
Section 529 of the Internal Revenue Code has listed certain qualified tuition programs that allow the tax payers to prepay or contribute to an account for paying a student’s qualified higher education expenses. Similarly, several colleges as well as college groups sponsor these 529 plans. These plans are becoming popular day by day. However, it may be remembered that although contribution to 529 plans are not deductible, it does not impose any income limit for the contributors.
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