How Does Education Impact Your Taxes?

• Learn about the latest updates on student loan forgiveness, including President Biden's new proposal and its impact on long-term borrowers.
• Understand how education expenses affect your taxes.
• Discover the details of the American Opportunity Tax Credit (AOTC), such as its maximum credit amount and eligibility criteria.
• Explore the Lifetime Learning Credit (LLC), its maximum credit amount, nonrefundable nature, and eligibility for various types of courses.

The kids are back in school! Things like student loans, scholarships, and fellowship grants can play a role in parents’ and college students’ tax liability. Fiducial has some insight into how education costs can impact your taxes.

Student Loan Forgiveness Update

Student debt is a hot topic. As of July 2023, total U.S. student loan debt stood at $1.774 trillion while the average federal student loan balance was $37,717. Recently, the Supreme Court struck down President Biden’s plan to provide blanket loan forgiveness to all student borrowers. President Biden then teamed with the Department of Education to announce a new proposal. The new rule expands on established law that provides debt relief for borrowers who made at least 240 or 300 monthly payments on their loan. The calculation now includes months where payments were late, partial, or deferred and helps those who have held student debt for a long time. At this time, we await a proposal to help more recent borrowers and those who stopped paying on their loans altogether.

Debt cancellation is generally taxable unless a provision of the tax code exempts it (such as student loan cancellation due to meeting a public service commitment). Under the American Rescue Plan of 2021, student loan debt cancellation is not subject to federal income tax until 2026. Most states mirror federal tax treatment, but some may differ and tax the student loan debt relief.

Taxable Income Qualifications

Scholarships and fellowship grants are not included in taxable income if certain conditions are met. Firstly, the student must be a candidate for a degree at an eligible educational institution. Additionally, the proceeds must be used for qualified expenses including tuition and fees, books, and other course-related expenses. They cannot be used for room and board, research, travel, and other expenses that aren't required for enrollment or attendance at the institution. Scholarships and fellowship grants are taxed as ordinary income if they do not meet the requirements.

Student Loan Interest Tax Deduction

You can deduct student loan interest payments of up to $2,500 per return if certain conditions are met. This deduction phases out with modified adjusted gross income (MAGI) between $70,000 and $80,000 if single and $145,000 and $175,000 if filing jointly. If you qualify, you can take this deduction even if you don’t itemize.

Available Tax Credits

Education costs can generate an American Opportunity Tax Credit (AOTC) and/or a Lifetime Learning Credit (LLC). While you can only claim one of these credits each year for each qualifying student, you can claim different credits for different students in the same year. They phase out with MAGI between $80,000 and $90,000 if single and $160,000 and $180,000 for joint filers.

The AOTC provides a credit of up to $2,500 for adjusted qualified education expenses paid for each eligible student. The AOTC is the sum of:

1. 100% of the first $2,000 of qualified education expenses you paid for the eligible student, and
2. 25% of the next $2,000 of these expenses.

Up to 40% of this credit or $1,000 is refundable. It’s available for up to four years of study per eligible student who has not already completed four years of postsecondary education. To qualify, the student must be enrolled at least half-time for at least one academic period and must not have been convicted of a felony for possessing or distributing a controlled substance.

Lifetime Learning Credit (LLC)

The Lifetime Learning Credit (LLC) offers a credit of up to $2,000 per return. The LLC is 20% of the first $10,000 of qualified education expenses you paid for eligible students. Qualified expenses include tuition and fees required for enrollment or attendance as well as amounts required to be paid to the institution for course-related books, supplies, and equipment. You can claim the credit even if the student withdraws unless the payments are refunded. Furthermore, the LLC is nonrefundable so it can only offset tax liability.

There is no limit to the number of years it can be claimed for each student and it can apply to courses taken to acquire or improve job skills. Generally, you must receive Form 1098-T from the institution to take the credit. If the institution isn't required to furnish it, you must be able to demonstrate that the student was enrolled at an eligible educational institution and substantiate your payment of qualified expenses. If the institution is required to provide it but you haven't received it, you can still take the credit if:

1. After January 31 but before you file your return, you ask the institution to provide it to you,
2. You fully cooperate with their efforts to gather the required information, and
3. You qualify for the benefit, can demonstrate that you were enrolled at an eligible institution, and you can substantiate the payment.

It turns out that a great education can pay off in life and in reduced taxes! Call Fiducial at 1-866-FIDUCIAL or request an appointment at one of our office locations to learn more about education tax deductions and credits available to you.

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