Variety of tax benefits help offset the cost of college

Parents at all income levels can find something that works for them among options that include 529 plans, tax deductions and tax credits.

Recent high school graduates may still be basking in the glow of their achievement, but their parents have likely moved on to thoughts of their child’s next phase of education. And while they will be excited for their children to take their next step toward adulthood, there’s a good chance those parents are also dreading what comes with it — that first tuition bill.

Fortunately, for many parents the tax code provides a variety of ways to use those college expenses to help reduce their tax liability. While there are restrictions and phaseouts that keep many families from qualifying for some of these benefits, parents at all income levels can find something that works for them.

Savings Accounts

Most parents are familiar with 529 accounts, as evidenced by the $319 billion invested in 13 million accounts as of the end of 2017, according to the College Savings Plans Network. The combination of tax-deferred growth and tax-free withdrawals is available to taxpayers at all income levels and likely makes 529 plans the primary tool to help offset the cost of college.

529s have essentially supplanted Coverdell accounts as the college savings vehicle of choice. Those who already have a Coverdell may find they still provide value, but for future savings, it’s hard to justify additional contributions to these accounts.

Tax Deductions

The tax code provides two types of deductions for those incurring college costs, although one has several limits on its effectiveness, while the other has currently expired and is awaiting a revival that may not come.

The student loan interest deduction allows borrowers to deduct up to $2,500 of interest on a qualified student loan. The deduction is phased out for couples with modified adjusted gross income between $135,000 and $165,000 (singles between $65,000 and $80,000), and it can only be claimed by the person legally obligated to pay the debt. This means that parents who help a student pay off loans in the student’s name cannot claim the deduction.

Fortunately, this deduction is technically an adjustment to income, which means those using the standard deduction rather than itemizing can still claim the benefit.

The tuition and fees deduction allows taxpayers to deduct up to $4,000 of qualifying expenses. This deduction expired after 2017, and it has yet to be renewed for 2018. But in previous years, the deduction has expired and been renewed, so it’s possible it will return again this year.

Tax Credits

There are two tax credits to choose from to help offset college costs — the American Opportunity Credit and the Lifetime Learning Credit — and there are several important differences between them.

The AOC is equal to 100% of the first $2,000 of qualifying undergraduate and graduate expenses, plus 25% of the next $2,000, for a maximum credit of $2,500. The credit is phased out for couples with MAGI between $160,000 and $180,000 (half that for singles), and it can only be claimed for the first four years of postsecondary education.

The LLC, on the other hand, is equal to 20% of the first $10,000 of qualifying expenses, for a maximum of $2,000. The phaseout level is lower — MAGI between $114,000 and $134,000 for couples (half that for singles) — so fewer families qualify. However, it can be claimed in an unlimited number of years and for courses related to building job skills, not just postsecondary education.

One important note: taxpayers aren’t allowed to “double dip” on the benefits. For example, if a tuition bill is paid using funds from a 529 plan, those same expenses can’t be used to qualify for one of the tax credits. Even so, when it comes to paying for college, every bit of help counts.

(More: New ways to pay for college)

Tim Steffen is director of advanced planning for Baird. Follow him on Twitter @TimSteffenCPA.