Well, we are at the end of August already! This is the month that young adults who are attending college are checking into their dorm rooms and have already begun or will soon begin their new semester.
Whether this is your child’s first year of college or not, chances are you are still claiming them as a dependent on your taxes if they are going to school full time. Now is a good time to make sure you understand the potential tax deduction and credits that you may be allowed when you file your 2015 taxes next year. No matter what credit or deduction you may receive, keep records of all expenses paid throughout the year. Here are some credits and deductions you may qualify for:
The American Opportunity Credit: This credit is available for the first four years of post-secondary education. The maximum credit is $2,500 per student, of which 40% of the credit is refundable. So if you had a zero tax liability, you would only receive 40% of the credit. Keep in mind that if the child is taking this credit on their tax return, it will generally not be refundable. Adjusted gross income (AGI) phase-out begins at $80,000 for a single filer and $160,000 for married filing joint.
Lifetime Learning Credit: This credit is a non-refundable tax credit of 20% of up to $10,000 of qualified tuition and fees paid during the tax year. Maximum credit is $2,000. This credit is per taxpayer, not per student, so the credit is the same regardless of the number of students in the taxpayer’s family. There is no limit on the number of years for which this credit can be claimed. AGI phase-out begins at $55,000 for a single files and $110,000 for married filing joint.
Tuition Fees Deduction: A maximum deduction of up to $4,000 of qualifying educational expenses may be allowed for the taxpayer, spouse or dependent. AGI phase-out begins at $80,000 for a single files and $160,000 for married filing joint. You may not take this deduction and one of the educational credits for the same student. There is no limit on the number of years for which this deduction can be claimed.
Student Loan Interest Deduction: You may be able to deduct up to $2,500 of interest paid on qualified education loans. The child must be claimed as your dependent for you to take this deduction, if you otherwise qualify. AGI phase-out begins at $65,000 for a single files and $130,000 for married filing joint.
Tip: If a loan is necessary, it may make sense for your child to take out the loan. For the Stafford Loan, the student has to apply, and that interest rate will generally be lower than what the parent’s loan rate will be. If repayment terms of the loan do not begin until after he/she graduates, it makes even more sense, since it is likely that the child will no longer qualify to be claimed as your dependent and will be able to then claim the interest deduction themselves if they otherwise qualify. Even with the student taking out the loan, you can always help them in repaying the loan.
A Stafford loan, for example, has a 4.29% interest rate for the 2015/2016 academic year (rates are adjusted each July 1st). If the loan is subsidized by the government, interest is not charged as long as the student is enrolled in school on at least a half-time basis. For an unsubsidized Stafford loan, interest starts accruing at the time of the loan.
If the parent must take out a loan, I would look at a home equity line of credit first, if one is available, since we are still in an era of record low interest rates. The Federal PLUS loan has a fixed rate for the 2015/2016 academic year of 6.84% that the parent could also look into. With a good credit rating, you should also look at your bank or credit union to see what rate they are offering. Bankrate.com is a good web site to check for loan rates as well. Generally, I would look at a loan prior to borrowing from your workplace retirement account. Remember, you can always borrow money for college, but you can’t borrow money for retirement!
If your child is receiving a scholarship or grant, such as the Pell Grant (which is needs based), you normally would calculate their Pell Grant funds as being used to pay for qualified education expenses, because their college applies the grant for tuition. This is not wrong, but that amount will decrease the expenses eligible to be used to claim an education credit like the American Opportunity Credit.
Pell Grants can now be allocated as living expenses, up to the full amount of actual living expenses — even if a student’s college actually applied the Pell Grant to his tuition and fees. The amount will then count as taxable income, but it might be worth it to maximize the education credit. Check with your tax professional on your specific situation.
It is important to keep good records of your expenses and money that has been paid out and from what sources. This will ensure that no matter which credit, deduction, grants and/or scholarships your student receives, your tax return can be completed more accurately to reap the biggest savings!