08 Feb No double-dipping on college tax breaks

Q. My daughter is a college freshman and I’m trying to figure out what deductions we can take. We paid part of the tuition from a 529 plan and the rest is loans. Help! — Taxing questions

A. There is almost always a no double-dipping rule when it comes to tax benefits.

Education tax credits and deductions are no different, said Cynthia Fusillo, a certified public accountant with Lassus Wherley in New Providence.

“Withdrawals from a 529 plan cannot be both tax-free and qualify you for an education credit,” Fusillo said.  “You can, however, use 529 money to pay for tuition which you then claim a credit for – you just cannot do both.”

Let’s take a closer look.

She said 529 plans are already tax-advantaged plans allowing you to put money aside for education purposes, with the intent to later withdraw the funds tax-free.

Therefore, the various education tax breaks that are available will not apply to you if you use 529 plan withdrawals to pay for these education expenses.

For expenses paid by other means, several possible tax breaks exist, she said.

Fusillo said there is a deduction for student loan interest, and, in fact, it’s an above-the line adjustment which means that you do not have to itemize to claim it. However, as with any potential tax deduction, this one also comes with some parameters.

First, she said, your daughter must be your dependent, which seems obvious but is not always the case.

“The loan must have been taken out solely for the purpose of paying for education for a student enrolled at least half-time in a degree or certificate program, or other recognized educational credential,” Fusillo said. “This would include tuition for such programs, as well as fees, room and board, books, supplies and equipment.”

She said the amount of the deduction is the lesser of $2,500 or the amount of interest paid annually.

There are limitations based upon Modified Adjusted Gross Income (MAGI), whereby the deduction is phased-out for MAGI over certain limits, Fusillo said. For example, a married couple filing a joint return has a reduced deduction when MAGI falls between $130,001 and $159,000, and the deduction is completely phased out for these filers when MAGI is $160,000 or more, she said.

Then there’s the American Opportunity Credit, which may be claimed against expenses up to $2,500 paid for each qualifying student, Fusillo said. It’s available for the first four years of post-secondary education. MAGI limits apply – for a married couple filing jointly the credit is disallowed when MAGI is $180,000 or more, she said.

“A portion of this credit, 40 percent to be exact, is refundable,” she said. “That means that up to $1,000 — $2,500 max credit x 40 percent — may be refunded to you if your tax liability falls below zero.”

There’s also the Lifetime Learning Credit, allows for up to $2,000 of qualified education expenses for all eligible students. Unlike the American Opportunity Credit, the LLC is not limited to four years, Fusillo said.

“You can claim this credit for an indefinite number of years, which can be useful as statistics show more and more college students adhering to the five year plan,” she said.

MAGI limits once again apply and for a married couple filing jointly, the LLC is disallowed for MAGI of $130,000 and higher. The LLC is non-refundable, meaning that it cannot reduce your tax below zero, she said.

Finally, there is a tuition and fees deduction.

“This is an above the line adjustment of up to $4,000 meaning again that you don’t have to itemize to take advantage of it,” she said. “MAGI limits are up to $159,999 for marrieds filing jointly. Once again you must choose between this deductions and one of the credits above.”

Fusillo said both the Lifetime Learning Credit, The American Opportunity Credit and the tuition and fees deduction may not be claimed if your filing status is married filing separately. In addition, you must choose between them so you don’t run afoul of the double dipping rules.

More information is available for your reading pleasure in IRS Publication 970, Tax Benefits For Education.

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This story was first posted in February 2016.