College is one of the most expensive investments a parent can make in a child's future. But there's a consolation prize that comes with the hefty price tag: bigger tax breaks.
With average yearly in-state costs at $13,589 for a public university and $32,307 for a private college, according to the College Board, any education tax break is a boon. But be careful; in most cases you can't use the room-and-board part of that bill — a sizable chunk of the cost — in figuring your tax benefit.
Still, two tax credits, a student loan interest deduction and a deduction for tuition and fees — not just for your dependent's education, but yours and your spouse's as well — can lessen the sting of college bills. Credits are among the tax code's biggest prizes because they are a dollar-for-dollar reduction in tax liability, while a deduction simply reduces the income against which tax is assessed.
Here are education tax benefits for 2007. You can claim them for qualifying education expenses for yourself, your spouse or a dependent for whom you claim an exemption on your tax return. You can't take any of them if your filing status is married filing separately.
Tax credits
There are two. Calculate them using Form 1098-T, which a college must send every enrolled student by the end of January. To claim a credit, attach Form 8863 to your 1040 or 1040A form.
The Hope credit, worth up to $1,650 per student in 2007, can be taken only in the first two years of post-secondary education, providing the student is enrolled at least half time. For each student you can claim 100 percent of the first $1,100 in qualified education expenses and 50 percent of the next $1,100.
The Lifetime Learning credit is worth up to $2,000 per return — not per student, so you can combine expenses from more than one student. This credit isn't limited to college expenses — non-degree work is OK, even if it's just a course or two. There's also no limit on the number of years in which the Lifetime Learning credit can be claimed. The calculation is 20 percent of the first $10,000 of qualifying education expenses.
Both credits phase out — gradually decrease — as income goes up. A taxpayer who has over $57,000 in modified adjusted gross income (AGI), $114,000 for joint filers, can't claim a credit.
Tuition and fees deduction
Depending on your income, you may be able to take a deduction of up to $2,000 or up to $4,000 for tuition and fees. But no deduction is allowed for modified AGI above $80,000 for single filers, $160,000 for joint filers. Use the new Form 8917 to figure the deduction; attach it to your 1040 or 1040A.
Interest on student loans
Up to $2,500 of interest on student loans is deductible. Taxpayers with modified AGI over $70,000 for individual filers, $140,000 for joint filers, don't qualify for the deduction.
Forms 1040 and 1040A have a worksheet for figuring this deduction, and the lender — a bank or other qualified institution — must send you Form 1098-E stating the amount of interest paid in 2007.
One of the bugaboos of figuring education tax benefits is the issue of what qualifies as education expenses. Generally, room and board aren't qualifying expenses for purposes of your 1040. Tuition and any mandatory fees — like a college's required Internet fee or student activity fee — are OK, if paid directly to the school. And if a student withdraws from college, you can deduct qualified education expenses not refunded by the institution.
Books, supplies and equipment like a computer don't qualify as education expenses, unless they're required by the school for enrollment or attendance and paid directly to the school. Those plane and bus tickets home? Not eligible.
The tax code is firmly against double-dipping; you can't claim both a tuition and fees deduction and an education tax credit for the same student in the same tax year. You can't take both tax credits for the same student that year.
You cannot take the credits or tuition and fees deduction for qualified education expenses paid with tax-advantaged funds from 529 tuition plans or the Coverdell Education Savings Account. You've already received the tax benefit from such accounts — the earnings and distributions aren't taxed if used for education.
Finally, you can't claim education credits or deductions if the student is also claiming them on his or her tax return. That may mean figuring your return and your student's tax return several ways to determine which way best helps the family's overall tax situation.
For more information on education tax benefits, see the Internal Revenue Service's Publication 970, "Tax Benefits for Education," available online at the IRS Web site.