Paying for college means you can shave a bit off of your tax bill for the year. The IRS has three college tuition benefits, in addition to a deduction for student loan interest. You can claim only one credit or one deduction per tax return. To claim either a deduction or a credit, you need to pay expenses at an eligible postsecondary institution, which means the school must participate in the federal student financial aid program. Eligible expenses usually include tuition and fees paid directly to the school.
Credit vs. Deduction
The major difference between a tax deduction and a tax credit is where the money is subtracted -- but that distinction is a big one. A deduction decreases your taxable income. A tax credit directly decreases the amount of tax you owe. Tax credits might be refundable, meaning you could get money back if the amount of the credit is more than the amount of the tax you owe. At the time of publication, the American Opportunity Credit is refundable up to 40 percent, but the Lifetime Learning Credit is not.
The amount you can deduct or claim as a credit varies. If you choose to take the American Opportunity Credit, you might be able to claim up to $2,500 per student per return, as long as you paid $2,500 in tuition. With the Lifetime Learning Credit, you can claim up to $2,000 per student, or 20 percent of $10,000. So if you paid $2,500 in tuition, you can claim a credit of $500. If you choose to take the tuition and fees deduction instead of a credit, you might be able to deduct up to $4,000 from your income.
As with many tax benefits, you must meet some income limits to claim either a deduction or a credit. As of 2012, the maximum modified adjusted gross income you could earn to deduct your tuition was $80,000 if single, or $160,000 if you filed a joint return. The income limit for the Lifetime Learning Credit was lower: $61,000 or $122,000. Income limits for the American Opportunity Credit are the same as they are for the tuition and fees deduction. Note that if you are married and file a separate return, you give up the option for the credit or the deduction.
Of the three options, the American Opportunity Credit is the least flexible. You can take it only if you are paying for the first four years of undergraduate schooling. The Lifetime Learning credit and tuition deduction are available no matter what year you are in or whether you are working toward a degree. You can take the deduction or claim a credit even if you paid for school with a loan, as you eventually will need to pay back that loan.
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