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Does College Debt Have Tax Benefits?

By TaxAct

The cost of higher education in America goes up every year.

For the 2013-2014 school year, the average annual price tag for tuition and fees at a public four-year college was $8,893 (in-state) and $22,203 (out-of-state).

The annual tuition and fees at private four-year colleges was more than $30,000 a year!

It’s no wonder that total student loan debt in the United States approached $1 trillion in 2014.

The good news is that the federal government recognizes the importance of investing in higher education and offers a number of tax breaks for college students and their families.

The three main tax advantages for college students come in the form of education-related tax credits, tax deductions and education savings accounts.

Tax credits are the best kind of tax break. Tweet this

Unlike deductions, which simply lower your total taxable income, tax credits are subtracted directly from your tax bill.

There are two types of tax credits available for college students and their families:

American Opportunity Tax Credit

Formerly known as the Hope Credit, this $2,500 credit is available for all four years of half- to full-time study.

This credit is refundable because it can actually generate a refund for people whose tax bill is less than $2,500.

If the student is a dependent, his or her parents are also eligible for the credit. The credit is phased out for higher-income earners.

Lifetime Learning Tax Credit

This credit is available for anyone taking college or vocational classes beyond high school.

There are no minimum enrollment requirements — you could take one class and qualify — and the credit covers 20 percent of education expenses up to $10,000 (in other words, a maximum of $2,000).

Same rules and limits apply for dependents and higher-income earners.

The IRS also offers several education-specific deductions to taxpayers. Deductions are expenses that lower your total taxable income.

The first deduction is for student loan interest. When you take out a student loan from the federal government, part of your monthly payment is pure interest on the loan.

The IRS allows you to deduct up to $2,500 of that interest from your taxable income to lessen the burden of those loans.

The second deduction is for higher education costs, including tuition and fees, up to $4,000.

There’s a catch, though. You can only claim this deduction if you did not claim either of the two tax credits outlined earlier.

If you’re a working adult and your employer covers all or a portion of your tuition for a continuing education or graduate program, those contributions can also be deducted from your taxable income.

You can deduct up to $5,250 annually for tuition, fees, books and supplies for qualifying education programs.

Of course, the best way to avoid a debt crisis in college is to start saving early. Tweet this

Does College Debt Have Tax Benefits? - TaxACT Blog

The federal government encourages long-term saving by giving tax breaks to folks who invest money in college savings accounts.

There are currently two types of tax-advantaged college savings accounts:

Coverdell Education Savings Account

Qualified taxpayers can invest up to $2,000 a year for students under the age of 18.

The money is not deducted from your taxable income, but you don’t have to pay any tax when you withdraw the funds, as long as they are used for education expenses.

Note that higher-income earners may not qualify.

529 Plan

These tax-deferred college savings plans are offered by individual states.

There are no income limits and you can invest as much as you want each year up to a maximum total amount.

Some 529 plans allow you to pre-pay tuition at a state university while others function like a managed investment account.

Contributions to a 529 plan can be deducted from your taxable income but withdrawals will be .

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