The smart college student's easy study guide for taxes

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Affording a college education has never been harder, and most students need every penny they can get. Fortunately, the Internal Revenue Service can often be a big contributor toward your college education by giving you and your parents valuable tax breaks to offset some of the costs of tuition and related expenses. In this guide, you'll learn about some of the tax credits, deductions and other breaks available to make getting a college education a little more manageable.

The Threshold Question: Are You a Dependent?

The first thing you have to figure out is whether you qualify as a dependent on your parents' tax return. For many college students, being a dependent is the ideal situation to get the most support from the IRS, as unless you have considerable amounts of income in your own right, you probably won't be able to make as much use of the tax breaks available as your parents can.

To be considered a dependent, you have to be a U.S. citizen or a resident of the U.S., Canada or Mexico, and you have to be a full-time student under the age of 24. You have to get at least half of your financial support from the family member claiming you as a dependent, and if you're married, you have to file a separate tax return from your spouse.

What's Taxable and What's Not

If you're fortunate enough to get a scholarship, then the tax law allows you to take that money without paying tax on it as long as you use it for qualifying education expenses, which include tuition, fees, and required books, equipment and other supplies. If your scholarship covers room and board, however, it's not exempt from taxation, which means that you'll have taxable income and could have to pay income tax on the amount used for ineligible expenses.

On the other hand, work-study programs and other jobs while you're in school generally don't qualify for tax-free treatment. Even if you use the money for tuition or other eligible expenses, you'll still have to include it on your tax return.

Credits, Deductions, and Other Breaks

College students can benefit from a wide array of available provisions to cut your or your parents' taxes. The American Opportunity Credit is available for your first four years of college education and offers a break of up to $2,500 on the first $4,000 you spend on annual educational costs. The credit pays 100 percent of your eligible expenses up to $2,000, and then adds another 25 percent for the next $2,000 in costs, to make your maximum annual credit amount $2,500. To qualify, you need to be enrolled at least half-time in a degree or certificate program. Best of all, students can claim 40 percent of the credit as a refundable tax credit, which means even if you don't have any tax liability at all, you can get as much as $1,000 back in the form of an IRS refund. The credit is fully available for single filers with $80,000 or less in adjusted gross income, or for joint filers with $160,000 or less in AGI.

For those who aren't eligible for the American Opportunity Credit, the Lifetime Learning Credit also offers valuable benefits. The Lifetime Learning Credit uses a simpler formula, paying 20 percent on up to $10,000 in eligible expenses every year, giving you a credit of as much as $2,000 annually. You can't double-dip with both credits in the same year, but you can use the American Opportunity Credit for the maximum period available and then use the Lifetime Learning Credit to cover graduate school or further educational needs. The full credit is available to single filers making less than $52,000 in AGI, or $104,000 for joint filers.

One tax provision that was recently renewed allows some students to deduct their tuition and fees. The provision allowed you to deduct as much as $4,000 in expenses per year, and higher income limits of $80,000 for singles or $160,000 for joint filers made it available to more families than the Lifetime Learning Credit discussed above. The provision had expired in 2013, but lawmakers just renewed it for 2014, and the deduction might not be available for future years.

Finally, once you start having to pay back any student loans you have, you can deduct as much as $2,500 in interest against your taxable income. These deductions aren't as valuable as credits, as they merely reduce your taxable income rather than directly cutting your tax liability. Nevertheless, the deduction can save you hundreds on your taxes if you qualify.

Motley Fool contributor Dan Caplinger finished college a year early to save money. You can follow him on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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