Higher Education Tax Benefits and Recaptures for 2020 and 2021

Written by: Matt Kuncaitis
Updated: 9/02/21

Education tax benefits can make everything from saving for college to paying off student loans a bit easier. Before you file your 2020 taxes – or plan a tax strategy for the 2021 tax year, check out these tax rules, credits, and deductions.

How Scholarship Money Is Taxed

If your student is fortunate enough to receive more scholarships than are needed to cover qualified education expenses, some of the money may count as taxable income. Tuition and fees, books supplies and equipment are untaxed while attending attending an eligible higher education institution on a path towards completing a degree.

 Scholarship money used for room and board, etc. requires income tax deduction. In addition, if you receive services such as for your laundry as part of your scholarships, the value of these services can also be taxed. The exception is if you receive the money as apart of a tax free program such as from the Armed Forces Health Profession scholarship and Financial Assistance Program.

What MAGI Is

Federal tax credits and deduction consider Modified Adjusted Gross Income (MAGI) to determine eligibility. Your MAGI is your adjusted gross income, you can  find on your tax return plus curtain deductions added back. The most common one added back is the student loan interest deduction. IRA contributions is another relatively common add back. For a full explanation of MAGI, we like this TurboTax article.  

The Student Loan Interest Deduction

The federal government allows up to $2,500 for tax year 2020 of your federal and / or private student loan interest charges to be deducted from your taxable income. To qualify, the loan must be in your name. Co-signing a loan doesn’t count. 

Your Modified Adjusted Gross Income, your income minus a few specific deductions must not not exceed $70,000 as a single filer or $140,000 as a joint filer to get the full deduction. If your income is within $15,000 per person above those amounts, you get a partial deduction based on how much you’re over. For instance, if you are single with a MAGI of $77,500, you could deduct $1,250 of student loan interest on your federal taxes because your income is half way through the $15,000 phaseout. 

American Opportunity Tax Credit

The American Opportunity Credit is the most generous of tax benefits for paying for college. The credit gives back up to $2,500 per year for the first four years of higher education. The student must be attending a higher education instead institution for at least half time status. The student also must be pursuing a degree or eligible credential.

Higher education expenses must be coursework in the previous year or the first 3 months of the current year. Thus, on 2020 tax returns, tuitions and fees could be from 2020 or early 2021.You can use one tax credit per student per year. Thus, if the student qualifies for the American Opportunity Credit, don’t claim the Lifetime Learning Credit as well.

Strategically, you may not want to claim the credit if only taking a few credits in that tax year. The reason is you can only claim the American Opportunity Credit for a total of 4 years. If you’re working on a four year degree and just took 12 credits, but will take 24 credits next year, you’ll likely want to save the credit for future years.

As far as income, you can claim the credit if your MAGI is below $180,000 if married filing jointly; and $90,000 if single, head of household, or qualifying widow(er).

How it works:

The first $2,000 is dollar for dollar of tuition, fees, and qualifying higher education expenses paid beyond scholarships, grants, 529 plan withdrawals, or employer-provided education assistance. The next $2,000 is credited at a rate of 25 percent. Thus, totaling up to a another $500 to refunds. The credit can be claimed by the parent if the student is their dependent, spouse, or themselves. Students can claim themselves, too. If the person claiming the credit doesn’t pay taxes, they can get back up to $1,000.

Example: A student’s tuition and fees were $10,000 and they received $4,000 in scholarships. There is $6,000 left to pay. If $4,000 out of pocket, you could get $2,500 back via the American Opportunity Credit. 

The Tuition and Fees Deduction

2020 is the last federal tax year the tuition and fees deduction can be claimed. It Reduces taxable income by up to $4,000. However, the excited part is it’s being replaced with higher income limits for the Lifetime Learning Credit tax credit that could help families  really pay for school.  

The income  limits to claim the deduction are $160,000 if married filing a joint return or $80,000 if single, head of household, or qualifying widow(er).

Lifetime Learning Credit

The Lifetime Learning has a lower income limit for 2020 when claiming the credit than the American Opportunity Credit, but it can be used beyond the first four years of education. The maximum MAGI to  receive the tax credit is $69,000 if filing by yourself or up to $138,000 if filing jointly. 

However, the maximum Lifetime Learning Credit is phased out between $59,000 and $69,000 for individual filers and $118,000 and $138,000, For instance, if an individual has a MAGI of $64,000 or a couple has a a MAGI of $128,000, they’ll get up to half ($1,000) the $2,000 credit.

You can claim the credit for an unlimited number of years for up to $2,000 per year (20 percent of $10,000) and is a credit against taxes. If you don’t pay any taxes that year, you won’t get the credit. It can be claimed by the person paying for higher education expenses, regardless of whether the student is themselves, the student, or their spouse. Unlike the American Opportunity Credit, only one credit can be claimed per tax return. 

529 College savings deductions, recaptures, and penalties 

529 education savings plans grow tax free as long as funds are used for approved higher education expenses, which can include room and board in addition to tuition and fees, books, equipment, and supplies. K-12 tuition or money withdrawing because a student received a scholarship can also be withdrawn without a 10 percent tax penalty.

A withdrawal does result in a tax penalty if it is for a non education expense. If the withdrawal is because a scholarship was awarded, you’ll pay income tax but not the penalty. 

Recapture

 There may be tuition credits or deductions in addition to tax credits and deductions on the state level. If you withdraw 529 plan funds for a non education expense and you received a tax deduction credit or deduction on the distribution, the state could ask for the deductions and credits you receive back. This can add up to a big pile cash. 

For instance, let’s say you contributed for $50,000. All of which was eligible for tax deduction that got you out of paying 5 percent income tax. You withdraw $50,000 for a non approved expense. You end up owing your state $2,500 plus potential penalties.

Double Dipping

You’ll hear the term double dipping, trying to take more than tax benefit off the same education expense, a lot with education tax benefits. It can have stiff penalties but is also easy to avoid. You can’t get two federal tax benefits on the same dollar of education costs. 529 plans, credits, etc. should be used for different parts of education expenses. If $4,000 of tuition is already getting a tax break, use 529 plan withdrawals for remaining tuition and fees or for room and board. Only one credit can be used per student. 

No matter what you do, read the details carefully when you decide on deductions and credits. Tax rules can change. I always refer to IRS publication 970 before deciding what deduction or credit you can use. Tax software will also provide information.

Amend Taxes for Past Years

You can amend your federal taxes for up to three years. Thus, you can go back and claim a deduction or credit you should have taken before.

Bottom line

The federal government offers several tax deductions and credits that can help you reduce the cost of yours or your student’s education. For most students in their first four years of higher education, the American Opportunity Credit is the best deduction. The Lifetime Learning Credit is generally the best afterwards and is increasing the maximum limit allowed. Since you can’t get more than one tax benefit off of the same education expense, plan carefully what money comes from which account and which benefits you can claim. You don’t want tax benefits to turn into tax penalties.

Guest post by Reyna Gobel.