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Monday, December 8, 2014

How to lower income taxes using educational costs

Education tax deductions
Educational tax deductions reduce taxable income
There are several ways education loans qualify for tax relief. Payments toward qualified student debt are eligible for income tax credits or deduction with certain restrictions. For example, each tax benefit has a maximum claimable amount between $2,000-$4,000. There also income caps that prevent higher-income earners from claiming tax perks. To determine eligibility for education tax incentives, a Form 1098-T and wage or income statements such as the W-2 or 1099-MISC are needed.

 

Student loan interest deduction

Individual tax filers with incomes below $75,000 and joint filers with incomes below $155,000 are able to take this tax deduction; it can lower taxable income by up to $2,500 in the 2013 tax year. This deduction is allowable for education loans not granted by employers or family members. The rules for this deduction allow loan origination fees from qualified educational institutions to also be classified as interest. Voluntary interest payments are also able to be included in the total interest deducted. Interest paid to institutions is required to be reported on Form 1098-E, which should be sent to the payee for each year of interest payment.

Tuition and fees deduction

This tax deduction reduces taxable income by as much as $4,000. The deduction can be taken without having to file a Schedule A or itemized deductions with the IRS. This tax incentive is allowable when the educational costs are for an institution that participates in a federal student aid program. However, nonprofit or private schools may also qualify. Individual tax filers with incomes above $80,000 and joint filers with incomes above $160,000 are disqualified from taking this deduction.

American opportunity tax credit

The American opportunity credit allows tax filers to claim up to $2,500 off taxes due. The credit cannot be taken in conjunction with the lifetime learning credit. Unlike the lifetime learning credit, there is a four year maximum for which the benefit can be claimed. If taking this credit creates a negative tax balance, then up to 40 percent of the credit or $1,000 may be refunded to the tax filer. In essence, this credit can actually increase annual income because of the refund potential. Individual tax payers with a MAGI above $90,000, and joint filers with MAGIs above $180,000 are excluded from this benefit.

Lifetime learning tax credit

The Lifetime learning credit has an income tax cap that determines eligibility. Specifically, the credit is reduced for single tax filers with modified adjusted gross incomes, or MAGIs, between $53,000-$63,000. If individual income is above $63,000, then the tax filer does not qualify for it. For married tax filers who do so jointly, the phase out income range is $107,000-$127,000. Unlike the American opportunity credit, this tax benefit of up to $2,000 does not qualify for refund of negative tax due balances.

These tax benefits are good for tax filers who earn enough income to make substantial payments on student debt. Unemployed and part-time workers are less likely to be able to claim the maximum credit and deduction, especially if they have no other source of income. Nevertheless, taxable income and tax can be lowered by a substantial amount when using the best allowable benefit. The IRS states neither of the aforementioned tax credits are useable alongside the tuition and fees deduction. These kinds of tax perks potentially eliminate or reduce tax filing rate for each year they are claimed.


Image license: 401(K) 2012, CC BY-SA 2.0