Don't Skip These 8 Tax Breaks for Students

Portrait of smiling university student standing in corridor during break, people in background talking
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By Damian Davila

Dear students, I'm sure that you have heard the news: Every single year the average student loan debt per borrower is increasing. For example, the average class of 2015 graduate with student loan debt will owe a little more than $35,000.

Still, there is a silver lining: College students and grads often qualify for significant tax breaks and deductions. To minimize your tax bill and increase your chances of a refund, here are eight tax deductions and breaks worth knowing about.

1. 529 Plans

If your parents or other donor started a 529 plan for you, you're in luck. Also known as qualified tuition programs, 529 plans allow individuals to save for education expenses on a tax-deferred basis and allow a designated beneficiary (ideally, that's you) to use those funds, including interest gains, for qualified expenses free of taxes or penalties.

But few people know that you can also start a 529 plan for yourself. Yes, if you anticipate returning to school for any reason, you can save for related expenses in your own 529 plan — at any age. The list of qualified education expenses goes beyond tuition and academic fees, including expenses for room and board, transportation, equipment, and accommodations for individuals with special needs, so adults can benefit, too. (See also: The 9 Best State 529 College Savings Plans)

2. Qualified IRA Distributions

Qualified distributions taken from a traditional IRA for use in qualified higher education expenses create no tax burden or penalty for you, assuming you only withdraw contributions, and not any earnings on the contributions. (Note: If your spouse, parent, or grandparent takes distributions from their own plans to fund your educational expenses, they would have to pay applicable income taxes on those funds, but don't have to pay the early distribution penalty which applies if under age 59 1/2.)

3. American Opportunity Credit

Replacing the Hope Scholarship credit, the American Opportunity Credit allows you to cover up to $2,500 of undergraduate college costs, including:
  • 100% of your first $2,000 qualified education expenses; and
  • 25% of next $2,000 qualified education expenses.

Keep in mind that you can claim the American Opportunity tax credit on your own academic expenses or on those of your spouse and kids. This means that you can claim up to $2,500 per student living in your household. However, to be eligible for the full credit, your modified adjusted gross income must be $80,000 or less (those making more receive a reduced amount of the credit).

Another advantage of this tax credit is that 40% of it is refundable, meaning that the IRS will issue a refund for that amount even if you don't owe any federal income tax.

4. Lifetime Learning Credit

The Lifetime Learning Credit allows you to deduct up to 20% of your first $10,000 in qualified education expenses, up to $2,000 per taxpayer.

Unlike the American Opportunity Credit, the Lifetime Learning Credit isn't refundable. You can use it to reduce any tax that you owe, but won't receive a refund for the unused portion when your tax bill is already zero.

However, the Lifetime Learning Credit doesn't require you to be working towards a degree like the American Opportunity Credits does. A single class makes you eligible for this tax credit.

To claim the American Opportunity and Lifetime Learning Credits, file Form 8863 with your federal return.

5. Business Deduction for Work-Related Education

The IRS allows you to deduct the costs of qualifying work-related education as business expenses as long as the education is:
  • Required by employer of by law;
  • Necessary to maintain or improve skills; or
  • Indispensable to meet minimum requirements.

You can also deduct qualifying transportation and travel expenses necessary for completing the education. For example, you can deduct 57.5 cents per mile driven and 50% of meals when traveling overnight for education purposes throughout 2015.

Make sure to keep all records, such as transcripts and catalogs of coursework, and receipts from all of your education expenses to provide sufficient support, especially in case of an IRS audit. A best practice is to obtain a statement from your employer providing details about your required education and reimbursements.

For more details, consult Chapter 12 from IRS Publication 970.

6. Coverdell Education Savings Account

Students under age 18, or of any age with special needs, don't pay any tax on distributions from Coverdell Education Saving Accounts for qualified education expenses at eligible institutions.
While there is no limit on the number of Coverdell Education Savings Accounts that can be opened for the same beneficiary, the total cash contribution to all accounts on behalf of the beneficiary cannot exceed a total of $2,000 per year. Contributions can only be made in cash.

7. Education Savings Bond Program

Series EE bonds issued after 1989 and Series I bonds qualify for the Education Savings Bond Program, allowing you to not pay tax on the interest earned on those U.S. savings bonds. While you can take the tax deduction for your own education, you must be at least 24 years old before the bond's issue date.
For additional eligibility criteria, such as modified adjusted gross income tiers, consult Chapter 10 from IRS Publication 970.

8. Scholarship and Fellowship Grants

Last but not least, the IRS exempts students from any taxes on funds from scholarship or fellowship grants that don't exceed qualified education expenses or represent payment for teaching, research, or other services.

To increase the combined value of educational credits and other types of educational assistance, the IRS recommends to coordinate Pell grants and other scholarships by including some or all of the additional assistance in income in the years it's received.

What are other tax deductions and breaks available for students?

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