Several tax benefits are available for college students or parents who are paying tuition for their dependents. The newest and most beneficial education tax credit is the American Opportunity Credit. This tax break which first became available in 2009 has been extended through 2012 and can be worth up to $2,500 for students in their first four years of college. To qualify the student must be enrolled at least half-time in a degree or certificate program and have out-of-pocket expenses for tuition, fees or books. Expenses paid with scholarships and grants do not count, but those paid with loans are eligible.
This is the only education tax credit which has both a nonrefundable and refundable feature. Sixty percent, up to $1,500 is nonrefundable, which means it can only be used to eliminate tax liability. For example, if a person's taxes are $1,400 then he can use only $1,400 of this portion of the credit. The refundable portion, up to $1,000, is credited as if it came from the taxpayer's wages and can be refunded even if he has no tax liability.
A less restrictive education tax credit is the Lifetime Learning Credit. This can be used an unlimited number of years and is not restricted to coursework for a degree or certificate. There is no minimum number of credits a person has to take, and can be used for someone who is simply taking a class to improve job skills or for personal satisfaction. This is strictly a nonrefundable credit with a maximum of $2,000 per year which can offset any tax liability.
Both the American Opportunity and Lifetime Learning credits have income limits. The limit for the American Opportunity is an adjusted gross income (AGI) of $90,000 ($180,000 if married filing jointly), and the limit for the Lifetime Learning is an AGI of $60,000 ($120,000 if married filing jointly). The person claiming the credit must be the one who claims the student on a tax return. For example, if a student is self-supporting, he may claim the credit. However, if the student is being supported by parents, then the parents are the only ones who can claim an education tax credit for those expenses.
There are other tax saving options available for someone attending college who does not qualify for an education tax credit. One of these is the Tuition and Fees Deduction, which is taken from gross income. This adjustment can lower taxable income up to $4,000 and does not require a minimum number of courses or that a student pursues a degree. The adjustment is phased out when AGI exceeds $80,000 (or $160,000 if married filing jointly).
People who itemize their deductions may also have the option of taking off the cost of work-related education expenses on Schedule A. These must be claimed as miscellaneous deductions which are subject to 2% AGI limitation. What the means is that all of the expenses allowed as miscellaneous deductions are added together, than 2% of the adjusted gross income is subtracted. If anything is left, then that amount is added to the Schedule A total.
Individual states also have tax-favored college savings programs, called Section 529 plans. All fifty states participate in some form of savings program, though the tax treatment may vary. Some states, such as Colorado, allow people to deduct their contributions from their state income taxes. As long as the money is eventually used for the beneficiary's college expenses, the funds and their earnings are not subject to state income tax.