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Back-to-School: Education Tax Incentives Refresher

With school starting up for another semester, now is the perfect time to brush up on your knowledge of education tax incentives. The federal government offers three incentives: tax credits, deductions, and savings plans.

Tax Credits

Tax credits are dollar-for-dollar reductions of your tax liability that can be refundable or nonrefundable. The following tax credits are available for education:

 

American Opportunity Credit

  • The maximum annual credit is $2,500.
    • 100% of first $2,000 of expenses and 25% of the next $2,000.
    • 40% refundable and 60% nonrefundable.
  • Applies to a taxpayer, spouse, or their dependent for the first four years of an undergraduate program.
  • Modified Adjusted Gross Income (AGI) Phase-Out limitations apply.

Lifetime Learning Credit

  • The maximum annual credit is $2,000.
    • 20% of up to $10,000 of expenses.
    • 100% nonrefundable.
  • Applies to a taxpayer, spouse, or their dependent for undergraduate and graduate programs.
  • Modified AGI Phase-Out limitations apply.

Tax Deductions

Tax deductions are “above-the-line” reductions of your taxable income. The following tax deductions are available for education expenses:

 

Student Loan Interest Deduction

  • The maximum annual deduction is $2,500 of interest paid on an education loan.
  • Applies to a taxpayer, spouse, or their dependent for undergraduate and graduate programs.
  • Modified AGI Phase-Out limitations apply.

Savings Plans

Savings plans are accounts funded by nondeductible contributions that allow earnings to grow tax-free, allow the distribution to be tax-free, or both. The following savings plans are available to help investors pay for education expenses:

 

Qualified Tuition Program (529 Savings Plan)

  • Grow tax-deferred, and qualified distributions are federal income tax-free.
  • Nondeductible contributions for federal purposes.
    • Some states allow deductions to residents.
  • Applies to the account beneficiary (can be anyone) for undergraduate and graduate programs.
  • Account owner can change beneficiary or reclaim funds and can elect to spread gift over five years.
  • Modified AGI Phase-Out limitations do not apply.
  • Annual distributions of up to $10,000 may be used for elementary school and high school tuition.


Coverdell Education Savings Account

  • Grow tax-deferred, and qualified distributions are federal income tax-free.
  • $2,000 nondeductible annual contribution maximum per child under age 18.
  • Applies to the account beneficiary (can be anyone) for K-12, undergraduate, and graduate programs.
  • Mandatory distributions at age 30, but can roll over to another family member.
  • Modified AGI Phase-Out limitations apply.

In general, using a savings plan creates the greatest tax benefit, but it also requires the greatest amount of future planning. Tax credits and deductions also provide tax benefits, but in many cases these can be phased out by income limitations. In some cases, these tax-saving instruments may be used in conjunction with one another to create even greater benefit.










Investors should consider carefully the investment objectives, risks, and charges and expenses associated with a 529 Plan before investing or sending money. The official program offering statement, which includes information on municipal fund securities, is available from your Financial Advisor and should be read carefully before investing. The value of a 529 account may fluctuate, and there is no guarantee that any investment portfolio will achieve the stated goal. Your investment may be worth more or less than its original value.

Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal income tax penalty. State tax treatment may differ. Investors should discuss their particular tax situation with a tax professional.

This article is meant to provide a general understanding of the tax topic above. Stifel does not provide tax advice. You should consult with your tax advisor regarding your particular situation.

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