Higher education can be a big investment. In fact, it is one of the biggest single investments outside of buying a home that most people make. If you have a child, grandchild, or a child you care for that is either currently pursuing or planning on pursuing higher education, there are quite a lot of tax breaks that can help you pay the bills.
Recently, the Consolidated Appropriations Act (CAA) was enacted and that made some changes to the tax breaks for higher education. Our blog details what changed and how these tax breaks could impact you and your family regarding higher education.
Deductions versus Credits
Before the CAA was enacted, there were a variety of tax breaks for “qualified education expenses.” This included the Tuition and Fees Deduction, the Lifetime Learning Credit, and the American Opportunity Tax Credit.
In general, tax credits are better than tax deductions. The deductions reduce your taxable income while the tax credit reduces the amount of taxes you will pay on a dollar-for-dollar basis.
What Are the Deductions
So for 2020, the Tuition and Fees Deduction is up to $4,000 at lower income levels or $2,000 at middle income levels. Deductions vary based on several things but those are the two ceilings. If your modified adjusted gross income (MAGI) for 2020 makes you eligible for these deductions, you can claim them regardless of if you itemize your deductions.
Here are the 2020 income thresholds for those deductions:
– With a $65,000 MAGI (or $130,000 if married and filing jointly), you could deduct qualified expenses up to $4,000.
– With a MAGI of $65,001 to $80,000 ($13,001 to $160,000 if married and filing jointly), you could deduct up to $2,000.
– If your MAGI is more than $80,000 (more than $160,000 if married and filing jointly), you cannot claim any deductions.
As noted below, the Tuition and Fees Deduction is not available after the 2020 tax year.
Two Credits Together
Before the new law, there was an unfavorable income phase-out rule that applied to the Lifetime Learning Credit. The Lifetime Learning Credit can be worth up to $2,000 annually. For 2021 and beyond, this unfavorable income phase-out has changed to align with the more favorable income phase-out for the American Opportunity Tax Credit.
The American Opportunity Tax Credit can be worth up to $2,500 per student per year.
The law also gets rid of the Tuition and Fees Deduction for 2021 and later. The law essentially trades the old law write-off for the new law’s phase-out rule.
Under the law, the CAA, the Lifetime Learning Credit and the American Opportunity Tax Credit phase out for 2021 and beyond for people with a MAGI of $80,001 to $90,000 for unmarried individuals ($160,001 to $180,000 for a married couple filing jointly).
Before this law, the Lifetime Learning Credit didn’t apply for people with a MAGI of $59,001 to $69,000 for unmarried individuals ( $118,001 to $138,000 for a married couple filing jointly).
The law gives the opportunity to get the credit to more people experiencing some of the burden of the cost of higher education.
What’s Best for You?
There are two remaining education tax credits to choose from. The experts at MCK can help you pick the one that works best for you in your situation. Each credit has its own requirements.
There are also a few other options to choose from:
– A Section 529 Tuition Plan: a tax-advantaged savings plan that can help cover the costs of K-12 as well as higher education and apprenticeships. The savings will grow tax-deferred and the withdrawals are tax-free if they are used to pay for qualified education expenses mostly limited to $10,000 in tuition costs.
– A Coverdell Education Savings Account: similar to the Section 529 Tuition Plan, Coverdell Education Savings Accounts grow tax deferred, and withdrawals are tax free. Unlike Section 529, withdrawals can apply to tuition, books, supplies, tutoring, and more.
Contact MCK today to see what’s best for you.