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Comparing Education Credit & Tuition Deduction

Comparing Education Credit & Tuition Deduction

The IRS offers three different tax incentives for higher education costs: the Lifetime Learning Credit, American Opportunity Credit, and the Tuition Deduction. However, you can only claim one education tax exemption per year, so choosing the one that earns you the most can make a big difference to your tax return as long as you are eligible.


Federal Tax Savings

For most people, American Opportunity Credit or Lifetime Learning Credit will provide greater income tax savings. American Opportunity Credit provides a maximum credit of $2,500, requiring only $4,000 of qualified expenses. The Lifetime Learning Credit offers a 20% credit to $10,000 in expenses, for a maximum of $2,000. Tuition fees and tax deductions allow you to deduct $4,000. Since this is a deduction, you must multiply the deduction by the tax rate to calculate the savings. For example, if you are in the 30% tax bracket, a deduction of $4,000 can save you $1,200.


Qualified Expenses

Qualified expenses for the three tax exemptions include tuition fees and necessary tuition fees; However, for American Opportunity Credit, you can cover the cost of books and supplies, even if you don't buy them in school. Additionally, to be eligible for American Opportunity Credit, you must have completed the first four years of post-secondary education. If you have a bachelor's degree, you cannot apply for American Opportunity Credit.


Other Criteria

Only students who do not have drug convictions on file can apply for American Opportunity Credit. Neither the lifetime learning credit nor the deduction of taxes and contributions has this requirement. In addition, all three tax advantages come with income restrictions. American Opportunity Credit has the highest income limits, followed by tuition fees and tax deductions. The lifetime learning credit has the lowest income limits.


State Taxes

The tuition and fee deduction represents an income adjustment, which reduces the gross income adjusted at the federal level. Over 40 states use federally adjusted gross income as the starting point for calculating income tax. As a result, taking tuition and fees deduction will generally reduce income tax and federal income tax. Tax credits, on the other hand, not.


What types of tax incentives are there for students and recent graduates?

Regardless of which education credit you qualify for, the American Opportunities Tax Credit or the Lifetime Learning Tax Credit work on the same principle. Tax credits reduce the tax bill by the actual value of the credit. In other words, when you calculate the total income tax for that year, one of those credits is taken right off the top, reducing your bill dollar for dollar.

On the other hand, the tuition and fees deduction has been deducted from your taxable income, but sadly, this is no longer an option. The 2017 Tax Cuts and Jobs Act removed the deduction.


American opportunity credit

American Opportunity Credit (AOC) is for undergraduates. The credit is specifically limited to expenses incurred during the first four years of college studies.

The credit can be up to $2,500, and up to $1,000 is refundable, which means you can get it back even if you don't owe any taxes. There is an income limit of $80,000 for single taxpayers to qualify for the credit ($160,000 if you are married and file a joint return). If your income exceeds these amounts, your credit will begin to decline.

Please note that the credit is available for each eligible student on the return. So a family with two students could get a $5,000 discount on their final tuition bill.


Lifetime learning credit

When U.S. opportunity credit is limited to the first four years of college education, Lifetime Learning Credit (LLC) is more widely available. The credit can be used for undergraduate, postgraduate, and even career or professional courses. There is no limit to the number of years you can apply.

In addition, the lifetime learning credit is calculated slightly differently. The credit's value is 20% of the first $10,000 of eligible tuition fees, so $2,000 per year is the maximum amount. But the problem is, it's per tax return, not per student.

The Lifetime Learning credit is also non-repayable, which means you are limited in your tax obligations. For example, if you qualify for a total credit amount of $2,000, but your tax debt was only $500 for that year, you will only receive a credit of $500.


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