Education Tax Credits for Undergraduate and Grad Students

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Planning and saving for your child’s college is something that many parents start thinking about even before their children are born. Questions such as, “where will they go to college?” and “how will we pay for school?” are usually top of mind.

Whether you have a child still in diapers or a high school student preparing for the next chapter in their educational career, there’s always something parents can be doing to prepare for the financial impact of college. You can open an NC 529 Account and make regular monthly contributions, and when they’re in college you can apply for financial aid for each year they’re enrolled. Another financial option you may want to explore is claiming eligible tax credits on your federal tax return.

While you’re likely more familiar with 529s and financial aid, you may not be aware of federal education tax credits. So, here’s a closer look at education tax credits that you may be eligible to claim to cover common student expenses for you, your spouse, or a child you claim as a dependent.

What Is an Education Tax Credit?

Education tax credits were created to increase college attendance and reduce the cost of higher education for Americans. An education tax credit can either decrease the amount of money you owe to the IRS when you file your taxes or increase the amount of your tax refund if you’re getting money back. To qualify for an education tax credit the student must attend an eligible institution that participates in the federal student aid program.

There are two education credits available to taxpayers. The American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Let’s start with the AOTC.

American Opportunity Tax Credit (AOTC)

The AOTC applies only to the first four years of post-secondary education, such as college and trade school. This generally would apply only to undergraduate students, unless the student was able to complete their undergraduate degree in less than four years. Then, they could potentially claim some or all of graduate school.

You can receive up to $2,500 per student, per year with the AOTC. It’s calculated as 100 percent of the first $2,000 of eligible education expenses, plus an additional 25 percent of the next $2,000 in expenses. So, to receive the full $2,500 tax credit, you will need to claim $4,000 in eligible educations expenses. These include tuition payments, required school fees, books, and other qualified expenses. Students must be enrolled in school at least half-time to claim the credit.

Taxpayers can qualify for the AOTC if their adjusted gross income is less than $90,000 for single parents, or $180,000 of you’re married filing jointly.

Lifetime Learning Credit (LLC)

The LLC is available if you or your student don’t qualify for the AOTC. The LLC is available for undergraduate, graduate, professional, and continuing degree courses. That means you, your spouse, and your child could take advantage of the LLC when you’re enrolled in college.

You can receive up to $2,000 per student, per year. The credit is calculated as 20 percent of the first $10,000 of higher education expenses you paid out of pocket, which totals $2,000. Qualified education expenses for the LLC include tuition, fees, books, and required course supplies. There’s no limit to how many years you can claim the LLC on your taxes.

The LLC does have lower income requirements than the AOTC. The maximum income you can make and still qualify for the LLC is $68,000 if you’re single or $136,000 if you’re married and filing jointly.

How to Claim an Education Tax Credit

If you paid tuition to an eligible institution, the school is required to send you a Form 1098-T, tuition statement. The form will list how much money you paid during the tax year. You can use that information to claim an education tax credit on your federal tax return. To claim the AOTC or the LLC, use FORM 8863, Education Credits.

You cannot claim the AOTC and the LLC for the same student in the same year. If you qualify for both tax credits, financial experts recommend you take the AOTC because you get a larger tax refund. You may want to discuss your options with a financial advisor to determine which tax credit is right for your family.

Will Tax Credits Affect My NC 529 Account?

So, will your tax-advantaged NC 529 Account be affected by tax credits? The answer is no if you plan carefully.

You can’t double-dip and claim an education tax credit and use a tax-free withdrawal from a 529 account to cover the same education expense. (This is also the case for tax-free grants and scholarships when claiming the AOTC or LLC.) However, remember that some education expenses, such as room and board, do not qualify for the AOTC or the LLC, but they are considered eligible expenses for the NC 529 Plan. Aside from tuition, room and board can be a huge expense for students who are living away from home during college. So, use your tax credits to cover as much of the tuition payments as possible. (That’s $4,000 if you’re claiming the AOTC or $10,000 for the LLC.) Then, you can use a tax-free NC 529 withdrawal to pay for any remaining tuition costs, living expenses, and other eligible education expenses not covered by the federal tax credit.

Tax credits and the NC 529 Plan are smart ways for families to lower the cost of post-secondary education and maximize their tax dollars! To learn more about the tax benefits of the NC 529 Plan, or to open an account, visit our website.

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