College is super expensive. And you may be inclined to procrastinate paying that tuition bill until the last possible date. But the tax benefit, a tax deduction or credit, of paying it by December 31st may be worth it.
But first, let’s start with a basic understanding of the difference between a “tax deduction” and a “tax credit”.
A deduction reduces the amount of your income that is subject to tax, which generally reduces the amount of tax you may have to pay. Tax deductions lower your tax liability by reducing your taxable income. Because a deduction lowers your taxable income, it lowers the amount of tax you owe, but by decreasing your taxable income — not by directly lowering your tax.
The other way to save money on your taxes is with a tax credit. This is a dollar-for-dollar reduction of the income tax owed, reducing the amount of tax you have to pay. Both options aid in reducing your tax burden.
So now that the basics of deductions vs credits are out of the way, let’s discuss the good news and the bad news. And let’s start with the bad news. (The good news is coming, I promise!)
You may recall that once upon a time there was the “Tuition and Fees Tax Deduction” which was brought back by Congress in late 2019 for Tax Years 2018, 2019, and 2020. It was available due to extensions that Congress had passed. However, beginning with 2021 and going forward, it has been repealed and is no longer available. (Yes, this is bad news.)
But wait, here’s the good news! There are 2 tax credits:
- The Lifetime Learning Credit – The amounts for this credit have been increased to compensate for the loss of the Tuitions and Fees Tax Deduction mentioned above. (So a little good news!)
Like many tax credits and deductions, the Lifetime Learning credit phases out for higher-income taxpayers. As of 2022, the LLTC phases out between $80,000 and $90,000 of modified adjusted gross income (MAGI) for single taxpayers. With a MAGI of $90,000 or higher, you can’t claim any credit as a single taxpayer. The range for joint filers is doubled, with the credit phasing out between $160,000 and $180,000 of MAGI. The maximum credit you can claim per year is $2,000, based on $10,000 in qualifying expenses.
- The American Opportunity Credit – This credit has a higher limit than the Lifetime Learning Credit, at $2,500, and the phase-out begins at higher MAGI levels as well. It can be claimed in amounts up to $2,500 per student, calculated as 100% of the first $2,000 in college costs and 25% of the next $2,000 of qualified expenses.
Another important distinction between the two credits is that up to 40 percent of the American Opportunity Credit is refundable, meaning you can actually receive money back if the amount of the credit exceeds your tax liability.
Here is why it may make sense to pay that tuition bill early. If you have not reached the amount of expenses needed to qualify for your education credit, by combing 2023 expense with your 2022 expenses, you may be able to benefit from either one or both of these credits.
Now for the details.
What qualifies as an expense? A qualified education expense is money you spend that is required to attend or enroll in an educational program at an eligible educational institution. This includes expenses such as tuition, fees, books, supplies, and other required course materials, but not room and board.
Most education tax credits are taken by parents. But they can be claimed by students who pay their own college expenses, file their own tax returns, and are not claimed as dependents on anyone else’s return.
If you claim a student as a dependent on your 2022 Tax Return, note that you can claim only one type of education credit per student dependent on your federal tax return each tax year.
Of course, this is just the tip of the iceberg when it comes to understanding education credits. If reducing your tax liability or increasing your refund is important to you, you may prefer to use an expert like us to make sure you are maximizing all your credits and deductions.
To learn more about us, visit www.SaundersTax.com. If you want to reserve an appointment for your taxes, call us at 301-714-2071. We have been helping our clients enjoy a Less Taxing Life and More Prosperous Solutions since 1984.