A Complete Study Guide to Student Taxes
The college experience is different for everyone. These days especially, college students can be just about any age, married or single, living with their parents, on campus, or on their own, working full or part-time, or even have kids of their own. They may be in a new state or even in another country. Then there’s the question of how they’re paying for their education – or if. Scholarships, loans, work-study programs, or maybe Daddy just writes a check. Whatever it takes, right?
Everything You Need to Know About Student Taxes
The cost of higher education has been a big news item and political hot button for years now. As the drama of the recent election begins to subside, one of the issues President Biden and Congress may choose to tackle is the difficulty of paying for college and other post-secondary training and education. As InsightHigherEd.com recently explained:
On the day Biden raised his right hand and put his left on a Bible, with his wife, Jill, a community college professor, at his side, college is not affordable to many. A study by the National College Attainment Network in 2019 estimated that in the 2017-18 school year, only 25 percent of public four-year colleges were affordable to students who qualify for Pell Grants. Even with grants, student loans and working 20 hours a week, on average nationally, they still fell short $2,406 annually of the cost of tuition and the other expenses of going to college.
In the meantime, the system continues chugging along and Americans keep finding ways to pay for school – sort of. If that’s you, future changes may help you reduce or eliminate student debt, or you may be on your own while the politicians keep arguing about it then move on to other things. What you can do, however, is make the most of currently available breaks on student taxes. Like owning a home or having kids, the government (for better or worse) likes to promote certain behaviors and choices through the tax code, and education is one of those choices.
Keep in mind that tax breaks are different for everyone depending on your particular circumstances. If you’re in school and still live at home, you may not be able to claim education deductions or credits yourself, but your parents could see the substantial benefit. If your income exceeds certain levels, it’s more difficult to qualify for some tax breaks – but that’s not such a bad problem to have. In general, however, there are a number of potential breaks when it comes to student taxes. Let’s look at a few of the most common so you’ll at least know what to look for when it’s time.
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Types of Benefits for Student Taxes
Not all tax breaks are created equal. A tax credit is often the easiest sort of tax benefit to understand, and the one which will usually have the most obvious impact on the math when you’re filing your return. A tax credit directly reduces the amount of income tax you have to pay. If you receive a $1000 tax credit for something, for example, your total taxes go down by $1000, period. If you owe less than that amount to begin with, a credit can result in a refund.
A deduction reduces the amount of your total income on which you’re expectzed to pay taxes. Deductions are still good, but very different from credits. Your total income taxes are based, of course, on your total income. Yes, there are lots of other things impacting your final obligation, but it all starts with how much you’ve made that year. A deduction is subtracted from that total amount before your taxes are figured, thus lowering your taxes indirectly by effectively lowering your income in the eyes of the I.R.S.
Finally, different sorts of savings programs may allow you to accumulate money tax-free. Sometimes this means your contributions can be taken out of a paycheck pre-tax, as with Health Savings Accounts. Other times it means you can earn interest over time without paying taxes on the gain. You may be able to use the money for specified purposes without paying taxes on it when you withdraw it from savings. Or, maybe you get all three of these benefits. They’re not deductions or credits on your tax return, but they involved money you’re able to use without paying the same taxes you would if the money were being spent on something else.
Credits Related to Student Taxes
There are two primary tax credits associated with education costs – the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC).
The AOTC
The AOTC is a rather general program designed to help almost any student with the expenses of post-secondary education. If you’re enrolled at least half-time and still in your first four years (usually this means you’re pursuing an Associate’s Degree or some sort of four-year undergraduate degree), you probably qualify. The AOTC will offset the costs of tuition, books, essential supplies, enrollment fees, etc., up to $2,500 each year for a maximum of four years. You can claim 100% of your expenses for the first $2,000, and 25% of your expenses for the next $2,000 – hence the $2,500 potential maximum.
The AOTC is a weird little credit in that students who qualify but owe less than their potential credit amount can receive up to 40% of the credit back as a refund. In other words, if you qualified for all $2,500 but owed zero taxes, you’d get $1,000 as a tax refund. (Hey, it’s better than nada but not quite as nice as getting the full amount.)
The LLC
The Lifetime Learning Credit (LLC) is similar, but designed to specifically promote the acquisition of a degree or certification which involves or supports job skills. The I.R.S. has a long list of qualifying institutions, but they don’t have to be traditional universities – trade schools and such can qualify as well. That makes the LLC both narrower and more flexible than the AOTC, but the LLC isn’t limited to undergraduate work. The credit covers 20% of your first $10,000 of qualified expenses, meaning a maximum of $2,000 per year. It’s also non-refundable. Even if you owe less than that overall, you won’t get a refund from the LLC.
If you’re one of the lucky souls who qualifies for both the AOTC and the LLC, you can pick the one which will get you the biggest credit that year – but you can’t claim both at the same time. Sorry! On the other hand, there’s no limit on the number of years you can claim the LLC, so cheer up – maybe once you’ve taken full advantage of one, you can start claiming the other.
Deductions Related to Student Taxes
There aren’t many deductions for students filing their 2020 taxes, I’m afraid. The tuition and fees deduction which was a given for so long was eliminated by the Tax Cuts and Jobs Act of 2017. What you might be able to deduct, however, is any interest you’re paying on student loans.
What is "MAGI"?
When you start doing your taxes, one of the first numbers you’ll be computing is your Modified Adjusted Gross Income (MAGI). Basically, this is your total income for the year, minus a few things that reduce your taxable income in the eyes of the I.R.S., but not minus all of them, because why should anything the government does be simple? If your MAGI for 2020 is less than $80,000 as an individual or $160,000 for a couple filing jointly, you’re probably eligible to deduct student loan interest.
The student loan interest deduction is taken as an adjustment to income, meaning you can claim it even if you don’t itemize. Kudos to whoever slid THAT detail into the legislation. It only applies to loans taken out for approved educational expenses, but these are pretty broad – tuition, textbooks, room and board (within reasonable limits), transportation (within limits), essential equipment (a laptop, maybe some pencils and a nice spiral with BTS on the cover), etc. The nice thing about student loans is that there’s no shortage of paperwork, so documentation shouldn’t be an issue.
Keep in mind that deductions merely lower your taxable income, so you’re reducing your MAGI by the amount of interest you’ve paid on student loans in order to pay taxes as if you made less money that year. Now, take this the way I mean it, but if things are going the way we hope they are, this won’t actually save you that much on your taxes. Surely you’d admit its’s better NOT to have so much student debt that the interest alone makes for a meaty tax deduction? The fact that there’s a $2,500 cap on how much you can deduct in student loan interest suggests, however, that perhaps this is not so uncommon after all.
Big or small, every deduction is a good deduction. Take it! Take it! Take it!
Student Taxes Related to Work
If you’re employed (even self-employed) and had expenses in 2020 for work-related education or training, you may be able to claim a deduction for these on your taxes. If your education expenses related to work in 2020 were more than 2% of your adjusted gross income, the additional amount you paid above that 2% is typically deductible when you itemize.
If you’re self-employed, the amount comes off of your self-employment income, reducing your taxable income not only for purposes of computing your income tax, but your self-employment tax as well. So… bonus!
What you can’t do is claim the same educational expenses under two different categories. If you qualify for and take advantage of the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC), you can’t double dip and deduct the same education costs as work-related expenses as well. The deduction also doesn’t apply for educational attainments not directly related to work but required in order to be considered for a position. For example, some job descriptions may include “must have a Bachelor’s degree or higher” as part of the requirements to be considered. That doesn’t qualify as “related to work” for this particular deduction, although it certainly doesn’t disqualify you for the more general deduction options discussed above.
Savings Plans Impacting Student Taxes
For many of us, college savings is something parents do for their kids. If you’re heading into college right out of high school, you probably haven’t earned enough yet in life to save up for more than maybe your textbooks or a new laptop. That’s OK, though – anything that helps parents pay for school probably helps the student as well.
529 Plan
You’ve probably heard of the “529 Plan.” It’s actually a lot of different education savings plans, varying from state to state plus including one run by private universities with its own small print and targeted beneficiaries. While the specifics will be different depending on where you live, these basically fall into two categories – College Savings Plans and Prepaid Tuition Plans.
College Savings Plans
College Savings Plans work pretty much like you’d expect, except that it’s really an investment program rather than a savings account. You set up a 529 account with a participating financial institution (mine was through our insurance company). You can start with a lump sum and add to it as you like, or set up regular payments to made automatically.
The rate at which your 529 grows (or shrinks) depends on the market as a whole, but generally, they’ve been reliable ways to maximize the ability of normal families to save for their kids’ college. 529 plans aren’t tax-deductible at a federal level, but withdrawals for approved purposes are tax-free. Over half of the states currently allow some sort of deduction for having a 529 plan, however, so that’s definitely worth looking into as you prepare to file your student taxes.
Prepaid Tuition Plans
Prepaid Tuition Plans are what the name suggests – a system allowing you to pre-pay part or all of the cost of an in-state public college education. This may sound a bit limiting, choosing your kids’ college so many years ahead of time, but many of these plans offer some flexibility if you choose to convert them to use at private or out-of-state institutions. Besides, most state options cover plenty of educational possibilities and offer substantial advantages – particularly if they’re already paid for.
Coverdell Education Savings Account
There’s also a Coverdell Education Savings Account (ESA) which operates somewhat like most 529 plans but includes provisions for paying for K-12 education expenses. We won’t go into it here, but I wanted you to be aware it existed and could have similar benefits when it comes to student taxes.
Preparing For Tax Time
This is just a general overview of some of the issues related to student taxes which you should be prepared from come tax time. As with anything related to filing your taxes, read the small print, do the calculations, and have a glass of wine nearby for emergencies. The key is to prepare as much as possible ahead of time so as to reduce your own stress and increase the odds you’ll remember everything. If you’re not sure where to begin, commit just 30 minutes a week to reading up on easy tax saving tips on Taxry or other reputable sites, or check out some of the easy-to-use tax tracker software out there. We live in amazing times, and while death and taxes may still be the only certain things in life, neither one has to be as unpleasant as they were when that phrase was first coined.
Besides, April isn’t such a horrible month. It’s often when we see the first signs of spring and start thinking about summer vacations or those projects we’ve been wanting to do around the house. It’s a time of hope and renewal emotionally and psychologically. For several of my neighbors, it’s when they finally take down their Christmas lights. (Honestly, by that time I’m not sure there’s really much point, but whatever.)
This April is going to be even better, and I don’t just mean because you’re going to be more prepared than ever to file your student taxes.
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Final Thoughts
I won’t go into the full spiel here, but the point is that tracking your spending, paying your bills, making investment decisions, comparing insurance companies, tracking interest rates, and anything else you keep wishing you were doing financially but can’t always find the time for, will suddenly be far more convenient than you could have imagined a few short years ago. And yes, it will even help you find the best local tax help if you like to guide you through the ins and outs of student taxes.
April is coming, and tax time with it. Don’t worry, though – you’ll do fine. Besides, you’ve got the coolest app ever to look forward to as well. That’s almost as good as noticing your neighbors finally taking down those lights!