Education Adjustments and Other Educational Incentives
Where to best (lowest tax liability = best) deduct educational expenses depends on the purpose of the education, if the expenses are for the taxpayer or a dependent, if the taxpayer is an employee or self-employed, and the taxpayer’s income. All of those factors will determine if an expense can be deducted, where to deduct it, and how much can be deducted.
Individual taxpayers have several opportunities for deducting educational expenses on a tax return, including:
Deducting student loan interest as an adjustment for AGI.
Deducting tuition and fees as an adjustment for AGI.
Deducting tuition, fees and other expenses as a self-employed taxpayer on Schedule C.
Deducting tuition, fees and other expenses paid by an employee as a miscellaneous itemized deduction on Schedule A.
Taking a Hope or lifetime learning tax credit on Form 1040.
While not a deduction for an employee, an employer can provide up to $5,250 in employer education assistance benefits tax free each year. The benefits must be for undergraduate tuition, fees, books, supplies, and equipment.
Student loan interest and a tuition and fees deduction are highlighted in this section and are covered again in Publication 970. An employee’s itemized deductions for education will be discussed in Chapter 5, Standard and Itemized Deductions; self-employed taxpayer’s educational expenses will be discussed in Chapter 7, Income: Self-Employment, Rental, Partnership, and Other; and educational tax credits will be discussed in Chapter 6, Special Tax Issues and Tax Credits.
Go to Publication 17 and read chapter 19: Education-Related Adjustments.
Student loan interest is deducted as an adjustment. A maximum of $2,500 in interest paid on a student loan may be deducted for student loans used to pay for qualifying expenses of the taxpayer, spouse, or dependent. The amount of the student loan interest is phased out if the modified AGI (AGI before the deduction for student loan interest) is between $55,000 and $145,000 depending on filing status as shown in Table 4.1, “Student Loan Interest Phaseout”.
Table 4.1. Student Loan Interest Phaseout
| Filing Status | Modified AGI | Deduction |
|---|---|---|
| Single | Not more than $55,000 | No reduction in deduction |
| Head of household | More than $55,000 but less than $70,000 | Reduced |
| Qualifying widow(er) | $70,000 or more | Eliminated |
| Married, filing jointly | Not more than $115,000 | No reduction in deduction |
| More than $115,000 but less than $145,000 | Reduced | |
| $145,000 or more | Eliminated |
To compute the deduction allowed when income is within the phaseout range, the amount of the interest is multiplied by a fraction with the modified AGI as the numerator and $15,000 ($30,000 in the case of a joint return) as the denominator.
Example
Ronda paid $800 interest on a student loan. Her 2008 modified AGI was $130,000 and she is filing a joint return. Ronda would deduct $400 = $800 × ($145,000 − 130,000)/$30,000. If Ronda had paid $2,750 in student loan interest, she could deduct $1,250 = $2,500 × ($145,000 − 130,000)/$30,000. The maximum deduction is $2,500, which is used in the phaseout computation.
Tuition and fees are also deducted as an adjustment. A deduction up to $4,000 can be taken for qualified education expensesqualified education expensesFor the student loan interest deduction, eligible expenses are tuition and fees, board, books, supplies and equipment, other necessary expense (e.g., transportation).. Table 4.2, “Tuition and Fees Deduction—Adjustment to Income” that follows has the requirements.
Table 4.2. Tuition and Fees Deduction—Adjustment to Income
| Maximum benefit | $4,000 |
| How to take the deduction | As an adjustment to income on Form 1040 |
| Eligible expenses | Tuition and fees required for enrollment or attendance at an eligible postsecondary education institution. |
| Ineligible expenses | Personal living or family expenses like room and board, medical expenses, transportation |
| Other restrictions | No deduction can be made for expenses paid for from tax free funds (e.g., scholarship). No double benefit is allowed (cannot also take a deduction for business expense). Higher income reduces the deduction. |
| Payment for | Taxpayer, spouse or dependent that can be claimed as an exemption |
The deduction is reduced as income increases as can be seen in Table 4.3, “Effect of Income in Tuition and Fees Deduction”.
Table 4.3. Effect of Income in Tuition and Fees Deduction
| Filing Status | Modified AGI | Maximum Deduction |
|---|---|---|
| Single | Not more than $65,000 | $4,000 |
| Head of household | More than $65,000 but less than $80,000 | $2,000 |
| Qualifying widow(er) | Over $80,000 | $4,000 |
| Not more than $130,000 | No deduction | |
| Married, filing jointly | More than $130,000 but less than $160,000 | $2,000 |
| Over $160,000 | No deduction |
Modified AGI for the tuition and fees deduction is computed by adding back the adjustments to income, foreign earned income exclusion, foreign housing deduction, and amounts excluded as income from Puerto Rico and Samoa.
Example
Bella is single and qualifies for tuition and fees deduction. Her AGI before modification is $72,000 and she has no items that need to be added back into AGI. Bella spent $3,800 on tuition and fees. Since Bella’s modified AGI falls between $65,000 and $80,000, she may deduct $2,000.
Educational savings accounts contributions are not deductible. Taxpayers can set up Coverdell educational savings accounts (once called educational IRAs) to pay for qualified higher education expenses. Contributions to an education savings account are not eligible for a tax deduction but earnings are tax free. Withdrawals from the account, if used for eligible expenses, are tax free even the portions that come from tax free earnings. There is a $2,000 annual limit on the amount that can be contributed to the account and the amount is phased out with AGIs between $95,000-$110,000 (filing single) and between $190,000-$220,000 (MFJ). In addition, amounts withdrawn and spent on nonqualified expenses are subject to tax.
Example
Stephanie is single and would like to contribute $2,000 to an educational savings account for her daughter. Stephanie’s AGI was $100,000 so her contribution is limited to $1,333 = $2,000 × (110,000 − 100,000)/$15,000.
Example
Tatyana receives a $3,000 distribution from her educational saving account and used $2,000 to pay for qualified educational expenses. The balance in Tatyana’s account prior to the distribution was $10,000 of which $7,000 was from her contributions. Since part of the distribution exceeded the amount spent on qualified expenses, a portion is taxable. The distribution is assumed to be pro rata from contributed (taxed) and earned (nontaxed) funds, so 70% of Tatyana’s balance would be a tax free return of capital and 30% would be a distribution of earnings. The distribution of tax free capital would be $2,100 ($3,000 × .7) and the distribution of earnings would be $900 ($3,000 × .3). The taxable portion of the distribution would be $300 = $1,000 × 30%.
Qualified tuition programsqualified tuition (or 529) programContributions to a savings program are not tax deductible but earnings are not taxed and withdrawals if spent on qualified expenses are not taxed. (often referred to as section 529 tuition plans) allow taxpayers to buy in-kind tuition credits or certificates for qualified higher education expenses, or to contribute to an account established to meet qualified higher education expenses. Many of these programs are sponsored by state governments and institutions of higher education. Contributions to the plans, like educational savings accounts, are not deductible on federal income tax returns but are deductible in some states. Earnings within the account are tax free and withdrawals, when spent on qualifying educational expenses, are also tax free. The qualifying expense definition is broader than educational savings accounts, with reasonable room, board, and equipment included. Unlike educational savings accounts, there is no income limit on the amount of contributions. Most programs have an overall limit of the amount that can be contributed.
As stated earlier in this section, qualified educational expenses might benefit a taxpayer as a different kind of deduction or credit, which will be discussed later.
Go to Publication 970 and read chapter 4: Student Loan Interest Deduction and chapter 6: Tuition and Fees Deduction.
Questions and Problems
Trisha finished her undergraduate degree using money from a student loan. She got a job and earned $36,000 her first year and paid $2,600 in interest. She can take as a deduction for AGI student loan interest in the amount of:
$2,600
$2,500
$1,500
$0
None of the above
Ross (a single taxpayer) has a salary of $90,500 and interest income of $15,500. Calculate the maximum contribution Ross is allowed for an educational savings account.
$2,000
$1,467
$533
$0
Some other amount
Alex receives a $1,500 distribution from his educational savings account. He uses $1,200 to pay for qualified higher education expenses. On the date of the distribution, Alex’s account balance is $5,000, $3,000 of which is his contributions. What is Alex’s taxable income (after any exclusion) from the distribution?
$1,500
$1,200
$300
$180
$120
Aurora receives a $2,000 distribution from her educational savings account. She uses $1,600 to pay for qualified higher education expenses. On the date of the distribution, Aurora’s account balance is $5,000, $2,500 of which is her contributions. What is Aurora’s taxable income (after any exclusion) from the distribution?
$1,600
$1,000
$800
$200
Some other amount
Which of the following is correct for qualified tuition programs?
Contributions are deductible and qualified educational expenses distributions are tax free.
Contributions are not deductible and qualified educational expenses distributions are tax free.
Contributions are deductible and qualified educational expenses distributions taxable.
Contributions are not deductible and qualified educational expenses distributions are taxable.
Ben received $15,000 (of which $4,000 is earnings) from a qualified tuition program. He does not use the funds to pay for tuition or other qualified higher education expenses. What amount is taxable?
$0
$4,000
$11,000
$15,000
For married taxpayers filing a joint return in 2008, at what AGI level does the phaseout limit for contributions to qualified tuition programs start?
$110,000
$190,000
$220,000
There is no phaseout limit on QTP contributions
Deb paid the following amount for her son to attend Sac State in 2008:
Item Amount Tuition $7,000 Room and Board 6,000 Books 700 A car to use at school 4,000 Student football tickets 300 Spending money 3,000 Total $21,000 How much of the above is qualified higher education expense for purposes of his qualified tuition program? $__________
Eliza withdraws $15,000 (of which $5,000 is earnings) from a qualified tuition program. She uses all of the funds for tuition, fees, and books. How much of the $15,000 will be taxable to Eliza? $__________
Jim and Karen file jointly. They paid, all in this year, the following expenses for his daughter’s first year at Cal Poly.
Item Amount Tuition $4,000 Room and Board 3,000 Books 900 Spending money 2,000 Total $9,900 If Jim and Karen’s modified adjusted gross income was $125,000, what amount could they deduct as an adjustment to income? $__________
If Jim and Karen’s modified adjusted gross income was $180,000, what amount could they deduct as an adjustment to income? $__________
Joel, a single taxpayer, still had $40,000 in student loan debt at the start of the year. He made all of his payments on time and paid $2,800 in student loan interest for the year. Joel was an accounting major and landed a really good job and his adjusted gross income before deducting student loan interest was $60,000. How much can Joel deduct as an adjustment for student loan interest for the year? $________
