Do you have a child or grandchild currently attending college? Congratulations!
To help cover the costs of post-secondary education, you may have saved up over the course of several years in a tax-favored account, such as a 529 plan. Once your child is enrolled in college, though, you may be able to claim a number of tax breaks.
For example:
1. Tuition tax credits
The American Opportunity Tax Credit (AOTC) can be taken up to $2,500 per student for the first four years of college. This includes a 100% credit for the first $2,000 and a 25% credit for the second $2,000 in tuition, fees, and books. This credit is 40% refundable up to $1,000, which means you can get a refund if the credit amount is higher than your tax liability.
You can also take the Lifetime Learning Credit (LLC) of up to $2,000 per family for each additional year of post-secondary education, which includes a 20% credit for up to $10,000 in tuition and fees.
That said, only one education tax credit can be claimed per eligible student per year. To claim the credit, the taxpayer must receive a Form 1098-T statement from the school.
Note that both credits will be phased out for those with certain modified adjusted gross income (MAGI):
- Between $160,000 and $180,000 for married couples filing jointly
- Between $80,000 and $90,000 for singles
2. Scholarships
If certain conditions are met, scholarships can be exempt from income tax. One of these conditions is that the scholarship cannot be compensation for services and must instead be used for tuition, fees, books, and supplies—not for room and board.
Remember that a tax-free scholarship will reduce the expenses considered when computing the AOTC and LLC. As a result, those credits may be reduced or eliminated.
3. Employer assistance
If your child’s college expenses are covered by your employer, that payment is considered a fringe benefit and is taxable to you as compensation.
If it’s part of a scholarship program outside of the pattern of employment, however, it will be treated as a scholarship—assuming the scholarship requirements are met.
4. Tax-exempt gifts
When someone gifts you money to cover your child’s college expenses, that person is generally subject to gift tax. For 2023, the gift tax exclusion threshold is $17,000 per recipient; married donors who give combined gifts may exclude gifts of up to $34,000.
However, if someone—such as a grandparent—submits your child’s tuition payments directly to the educational institution, there is an unlimited gift tax exclusion. This applies only to direct tuition costs (as opposed to room and board, books, supplies, and more).
5. Retirement account withdrawals
You can withdraw money from your IRA or Roth IRA account at any time without incurring the 10% early withdrawal penalty, as long as those withdrawals are used to pay for college costs. Note, however, that the distributions are subject to tax under the usual rules.
You may also have the option to withdraw from or borrow against your employer retirement plan—but before doing so, ensure you fully understand any and all tax implications, including any potential penalties.
Plan ahead with Smolin
Not all of the above-mentioned tax breaks can be used in the same year, and some may also impact qualification amounts for other tax breaks.
Not sure which option is best for your situation? Our CPAs can help. Contact us if you would like to discuss any of these options, or other alternatives that may apply to your situation.