The ABCs of Higher Education Tax Breaks
The Tax Cuts and Jobs Act (TCJA) includes many changes that affect individual taxpayers. But, in terms of tax breaks for higher education, the new tax law generally maintains the status quo, with a few minor tweaks here and there. Here's the rundown on education-related tax breaks for 2018 and beyond.
TCJA Eliminates Employee Deductions for Job-Related Education Costs
For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) eliminates itemized deductions for miscellaneous expenses that were previously subject to the 2%-of-adjusted-gross-income (AGI) deduction threshold. Because most people didn't have enough miscellaneous expenses to exceed the 2%-of-AGI deduction threshold, this write-off never got much attention. But it was an important tax benefit for employees who wanted to deduct work-related education expenses that their employers didn't cover.
Under prior law, you could generally claim deductions if the education maintained or improved skills used in your current job or profession. For example, the cost to obtain an MBA degree would often qualify. But for 2018 through 2025, employee deductions for work-related education expenses are suspended.
Exception for the Self-Employed
If you're self-employed as a sole proprietor, partner or member of a limited liability company (LLC), you can still deduct education expenses that are related to your current business on your business tax form. You don't have to worry about the TCJA's elimination of deductions for work-related education expenses incurred by employees. However, you can't deduct the cost of education that prepares you for a new job, business or profession.
The TCJA retains two valuable tax credits for higher education costs.
1. American Opportunity credit. This credit equals 100% of the first $2,000 of qualified postsecondary education expenses, plus 25% of the next $2,000 (assuming the phaseout rule explained later doesn't affect you). So, the maximum annual credit is $2,500.
The American Opportunity credit is allowed only for expenses for a year during which the student carries, for at least one academic period beginning in that year, at least half of a full-time course load in a program that would result in an associate's degree, bachelor's degree or some other recognized credential. So to be eligible, you have to be a fairly serious student but you don't have to go to school full time or actually intend to complete a degree or credential program.
The American Opportunity credit is phased out (reduced or eliminated) if your modified adjusted gross income (MAGI) is between:
- $80,000 and $90,000 for single taxpayers, or
- $160,000 and $180,000 for married joint filers.
In addition, you're ineligible for the American Opportunity credit if you've already completed four years of undergraduate college work as of the beginning of the tax year in question.
2. Lifetime Learning credit. This credit equals 20% of up to $10,000 of qualified education expenses. The maximum credit is $2,000. You can use this credit to help offset costs for undergraduate study when you're carrying a limited course load, after the first four years (when the American Opportunity credit is unavailable), or for graduate school or miscellaneous training and courses.
For 2018, the Lifetime Learning credit is phased out (reduced or eliminated) if your MAGI is between:
- $57,000 and $67,000 for single taxpayers, or
- $114,000 and $134,000 for married joint filers.
The phaseout ranges for the Lifetime Learning credit are much lower than the ranges for the American Opportunity credit, which means they are much more likely to affect you.
Numerous rules and restrictions apply to these two higher education credits. For example, to qualify for either the American Opportunity or Lifetime Learning credit, the student must attend an "eligible" institution. Virtually all accredited public, nonprofit and for-profit postsecondary schools meet this definition, along with some vocational schools.
Both credits are available for qualified expenses incurred for you, your spouse and your dependent children. Qualified expenses include tuition, mandatory enrollment fees and course materials (including books). However, room and board costs and any optional fees (such as for student activities, athletics and health insurance) don't qualify.
Some Factors Disqualify You
Taxpayers who are married but don't file jointly with their spouse are ineligible for both the American Opportunity and Lifetime Learning credits.
Only one Lifetime credit can be claimed on your return even if you have several students in the family.
And you can't claim both the American Opportunity credit and the Lifetime Learning credit for the same student for the same year. However, you can potentially claim the American Opportunity credit for one or more students and the Lifetime Learning credit for another.
Important note: Got a college student with a part-time or summer job? Consider having your child claim these credits if you're a high-income taxpayer, instead of claiming them yourself. Your child is less likely to run into the phaseout rules. There are some caveats to using this strategy, however. First, your child must have enough taxable income to benefit from the credit. In addition, you won't be able to claim a dependent exemption deduction for the child. But the TCJA eliminates dependent exemption deductions for 2018 through 2025; so, there's generally no tax cost for doing this except the possible loss of the $500 credit for older dependent children.
Tuition and Fees Deduction
The American Opportunity and Lifetime Learning tax credits aren't always available for family education expenses. For example, a student might not meet the eligibility rules, or your income might be too high. Fortunately, there's another important break for higher education costs to consider: a limited above-the-line deduction for eligible higher education tuition and fees. The term "above-the-line" means you don't need to itemize to benefit.
For 2017, if you were unmarried with MAGI of $65,000 or less (or married filing jointly with MAGI of $130,000 or less), the tuition and fees deduction equaled the lesser of:
- $4,000, or
- 100% of eligible expenses.
For 2017, if you were unmarried with MAGI between $65,001 and $80,000 (or married filing jointly with MAGI between $130,001 and $160,000), the maximum deduction was the lesser of:
- $2,000, or
- 100% of eligible expenses.
Single people with MAGI above $80,000 (or married people filing jointly with MAGI above $160,000) were ineligible for this deduction for 2017.
Unfortunately, this deduction expired at the end of 2017. However, it has become one of the "extenders" that Congress typically renews near year end.
If this break is extended for 2018, here are seven rules and restrictions to consider:
1. You can't claim this deduction if you claim either the American Opportunity credit or the Lifetime Learning credit for the same student's expenses for the same year.
2. You can claim the deduction for one child's expenses (or for your own expenses) and claim credits for expenses incurred by other students in the family.
3. If you're married, you must file a joint return with your spouse to be eligible for the deduction.
4. You must already have a high school diploma or GED to claim the deduction.
5. Eligible expenses include tuition, mandatory enrollment fees and course materials (including books and supplies). However, you can deduct course materials only if you are required to purchase them directly from the school. In addition, room and board costs and any optional fees (such as student activities, athletics and health insurance) don't qualify.
6. The student must attend an eligible institution.
7. If the deduction is resurrected for 2018, you can claim it for eligible expenses that are paid in 2018 for courses that begin in 2018 or for eligible expenses paid in 2018 for courses that begin in January through March of 2019. So, prepaying some expenses that are due early in 2019 could lower your 2018 tax bill.
Deduction for Student Loan Interest
If you pay interest on education loans, you may be eligible to claim an above-the-line deduction — depending on your income. The maximum annual write-off is $2,500. To qualify for the interest deduction, the student debt must have been incurred within a reasonable time before or after eligible higher education expenses were incurred.
Eligible expenses are defined as tuition, fees, room and board, and related expenses (such as books and supplies for the taxpayer, spouse, or any dependent of the taxpayer) to attend an eligible educational institution.
This deduction is allowed only for expenses attributable to a year during which the student carries, for at least one academic period beginning in that year, at least half of a full-time course load in a program. To qualify, the academic program needs to result in an associate's degree, bachelor's degree or some other recognized credential.
For 2018, the deduction is phased out for unmarried taxpayers with MAGI between $65,000 and $80,000. For joint filers, the phaseout range is between MAGI of $135,000 and $165,000. Married individuals who file separate returns are ineligible for this break.
There are multiple tax breaks for higher education costs to consider with multiple sets of rules, and several different breaks can potentially be available for the same expenses. Your tax professional can help you sort through the latest rules and advise you on how to get the most tax-savings from your higher education expenses.