If you are a lower- or moderate-income student or parent who worries about rising college costs, keep in mind that federal tax benefits exist that ease the financial burden of getting an undergraduate degree or completing a college or vocational training class. Two such tax benefits are the American Opportunity Tax Credit, which was made permanent by the Protecting Americans from Tax Hikes Act of 2015, and the Lifetime Learning Credit of 1997.
While taxpayers can no longer deduct college tuition and other education- related costs, Congress made up for it by expanding income limits for those working on a college degree or learning credits. For instance, the AOTC phases out at $160,000 for joint filers and $80,000 for single taxpayers.
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Read more: Tax Credits: What Are They & How Do You Qualify?
American Opportunity Credit
The American Opportunity Credit (AOC) allows a student or a parent, if the student is a dependent, to decrease their annual tax liability by as much as $2,500 each year for four years, assuming that the student's college expenses totaled $2,500 or more for the tax year.
If this is the case, either the undergraduate or parent can claim the first $2,000 of the student's college expenses, such as tuition, school fees and books or other supplies, plus 25 percent of any additional costs up to $2,000 for another $500 tax break. The $2,500 in costs must exclude living expenses or transportation costs.
A primary benefit of the AOC stems from the way that a deduction differs from a credit. Although a $2,000 tax credit may appear to be less than a $4,000 deduction, the credit reduces the taxpayer's tax liability by a greater amount than does the deduction. This is because the dollar benefit of a deduction depends on the taxpayer's tax rate but the tax credit is subtracted from the taxpayer's tax liability.
For instance, assuming a taxpayer's tax rate is 10 percent, a $4,000 tax deduction reduces the individual's tax liability by $400. In contrast, a $2,500 tax credit reduces the individual's tax liability by $2,500.
To claim the full credit of $2,500, the modified adjusted gross income (MAGI) of the single filer – parent or student – must be $80,000 or less in 2021. The maximum income for the married filing jointly couple is $160,000. If you have no income but fund the undergraduate education of an undergraduate, you can receive 40 percent of the AOC tax credit value or $1,000.
Read More: Education Credit vs. Tuition Deduction
Lifetime Learning Credit
When a parent or student claims the Lifetime Learning Credit (LLC), the taxpayer lowers their tax bill by as much as $2,000 or 20 percent of the first $10,000 of school tuition and fees. Eligible fees exclude living and transportation expenses.
Eligible students enrolled in courses at an eligible college, university, vocational school, or other postsecondary institution (including courses to acquire or improve job skills) can claim the lifetime learning credit. There is no limit on the number of years the student can claim the credit.
For a student's parent(s) to claim the credit, the student must be listed on the parent's tax return as a dependent. The taxpayer can claim the American Opportunity Tax Credit as well as the Lifetime Learning Credit, but not in the same tax year.
Amount of Life Learning Credit Claimed
The dollar amount of the LLC tax credit that a taxpayer can claim is limited by their modified adjusted gross income (MAGI.) To qualify for the entire tax credit of $2,000, the single filer's MAGI must be $59,000 or less in 2021. In turn, the income of the paying parents who file taxes jointly must be $118,000 or less to claim the entire credit.
If the MAGI of the single filer is more than $59,000 but less than $69,000, the tax credit the taxpayer can claim is reduced. The same is true for parents who file jointly and earn more than $118,000 but less than $138,000. The LLC tax credit is not available to those whose income exceeds $135,000.