Student Financing & Taxes

by Tim Isbell, February 2018

I coach a few young adult students in college decisions, career planning, and the financial dimensions that come along with their season of life. Since it's tax season, I want to make sure they file their taxes wisely. So, I did a little research and decided to post it here on my site for everyone.

There are two federal tax breaks that help students with educational expenses. Neither of these requires you to itemize deductions, so you can still file the short form. And they both survived the recent rewrite of the tax code, meaning they apply for the 2017 tax year and will also apply in 2018 and beyond. 

Some states also offer tax breaks for students, but you'll have to check these for your particular state.

American Opportunity Tax Credit (for students while in school) 

This is not a deduction; it’s a tax credit of up to $2500/yr - meaning it subtracts directly from your bottom-line taxes, so you can use it whether you itemize or not. It is available for up to four years and can be used in vocational schools as well as in colleges and universities. The $2500 limit decreases depending on your taxable income. 

Even if you don’t have $2500 of school expenses in the year, you can get a tax credit for what you do have plus 40% of the difference between that and $2500 limit. So, suppose you only have $1500 in qualifying educational expenses, you can get a tax credit for that $1500 plus 40% of the remaining $1000. That’s a $1900 tax credit. If that’s more than the taxes you owe for the year, the IRS will send it back to you as part of your tax "refund!" 

You will need to file IRS Form 8863 together with IRS Form 1040 or 1040A. Your school will provide the amount of interest you paid on Form 1098-T.


Student Loan above-the-line Interest Deduction 

This is a deduction of up to $2500/yr that subtracts from your income, so you do not need to itemize your deductions on the long form. It's available for the life of the loan. The $2500 limit decreases depending on your taxable income.

So, suppose you're a student on your own and you're in the 15% federal tax bracket and last year you paid $2500 in interest on your student loans. Then this tax break is worth 0.15 times $2500 = $375 at your bottom line. That certainly justifies the time it takes to fill out an extra form. 

You will need to file IRSForm 8863 together with IRS Form 1040 or 1040A. Your lender(s) will provide the amount of interest you paid on Form 1098-E.

Who claims these credits/deductions, me or my parent(s)? 

Generally, whoever claims you as a dependent can claim the tax benefit. For more, see Who Claims Educational Deductions?


All the best,

Tim

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