Back-to-School Tax Breaks for College Students

It’s officially back-to-school season, and as students prepare for the upcoming school year, taxpaying parents and guardians should keep in mind the various tax savings opportunities available to help potentially offset the cost of higher education. Matt Keefer, Tax Director at Gorfine, Schiller & Gardyn, reveals the top college-related tax breaks for 2021 in a recent Q&A.

Q: What are the current higher education tax credits that are available right now?

A: There are currently two credits available to taxpayers: (1) American Opportunity Tax Credit (AOTC) and (2) Lifetime Learning Credit (LLC).

The AOTC provides the most benefits for taxpayers. It is a $2,500 credit per student based on eligible qualified expenses for tuition and fees and certain types of expenses. For example, if you have four students in your family, you are eligible to $10,000 of the credit to use against taxes. If there is a situation where you do not have any tax, this is potentially a refundable credit of up to 40%.

To qualify, you must have at least $2,500 of the qualified expenses per student in order to receive the maximum credit. The eligible student, spouse, or a claimed dependent has to be a taxpayer to qualify. One of the most challenging thresholds taxpayers face with this credit is the AGI phase-out. If you are married filing jointly, the credit begins to phase-out once your AGI reaches $160,000, and once you reach $180,000, it is fully phased-out. For other taxpayers, single or married filing separate, it begins at $80,000, and is fully phased-out at $90,000.

The AOTC is only available for the first four years of postsecondary education, and the student must be at least half-time enrolled. Additionally, students cannot have a felony drug violation.

The LLC is a $2,000 per-return credit, not per student like the AOTC. The benefit of the LLC is it applies to more than just the first four years of post-secondary education. It can be for any post-secondary degree program, even if it is just part-time. The LLC also includes courses to acquire or improve job skills, if not part of a post-secondary degree. There is not a limit on the amount of years that it can be claimed for each student. The LLC’s thresholds are lower for the phase-out, so married filing jointly starts at $118,000, and at $138,000, it is fully phased-out. For other taxpayers, single, married filing separate, the phase-out begins at $59,000 and is fully phased-out at $69,000.

Most taxpayers tend to choose the AOTC unless the post four years of post-secondary education or courses related to improving job skills is applicable.

Q: What are the benefits of a 529 plan for college savings?

A: A 529 plan is a state-based, sponsored plan. There are two types: prepaid tuition plans and education savings plans, and every state offers at least one type of the 529 plan. In the state of Maryland, there is a prepaid tuition plan where a taxpayer pays tuition based on today’s rates and locks in rates for the future. There are some restrictions, so it is important to weigh the pros and cons of whether you want to choose a prepaid tuition or education savings plan in Maryland. The education savings plan is similar to a typical savings plan where a taxpayer contributes money into the plan and it is then invested and grows.

There is no federal deduction for contributing to a 529 plan. The states have a deduction available for state income taxes. For example, in the state of Maryland, taxpayers receive a $2,500 deduction per plan, per beneficiary. If a husband and wife each set up a plan for their child, there is the potential for a $5,000 deduction. However, it is not a significant amount of tax savings because the top rate in Maryland is only about 9%.

An additional benefit of the 529 plans is the tax-free growth of all the contributions put into the plan. Further, when the funds are withdrawn for qualified education expenses, the distributions are also tax-free.

Lastly, taxpayers can potentially transfer the account to a different beneficiary. For instance, if a child does not end up going to school, it is possible to transfer the funds to a different child.

Q: What are the benefits of the Coverdell Education Savings Account (Coverdell ESA)?

A: The Coverdell ESA is very similar to the 529 plan, but much more restrictive. The 529 plan does not have a contribution limit, whereas the Coverdell ESA does. The maximum, per beneficiary, to contribute is only $2,000. Once the beneficiary attains the age of 18, you can no longer contribute to the ESA unless the beneficiary has special needs.

There are phase-outs involved for contributing to it as well, similar to the AOTC. Married filing jointly starts at $190,000, and once you reach $220,000, you can no longer make contributions. For single filers, the phase-out starts at $95,000 and is fully phased-out at $110,000. The rules are similar to the 529 plan as far as tax-free earnings and distributions. Similar to the 529 plans, funds can be transferred from one child to the next if a child no longer attends school; although, a Coverdell ESA is more limiting.

Q: Parents are always thinking about scholarships to help reduce the cost of higher education. What are common tax implications with scholarships?

A: Scholarships are typically excluded from gross income, but that is contingent on the scholarship not exceeding the amount of qualified tuition and related expenses. If a student receives a large scholarship that well exceeds the cost of tuition and related expenses, they would actually have taxable income to report. You cannot exclude from gross income any amount of the scholarship that is considered for teaching, research, or other services that are required to be performed as a condition for receiving the scholarship. There are cases where the college may not provide a W-2 to the student, but if they have teaching, research, or other services, they would still have to report the income.

Q: How can Gorfine, Schiller & Gardyn help with college tax breaks?

A:Each one of these items has different intricacies, so taxpayers may or may not qualify, or they may have specific questions on whether they qualify. We are certainly here to help assist on whether a taxpayer qualifies for the different savings, and there are different types of tax planning strategies that can be done in regards to the AGI phase-outs where we can assist.

It is never too early to start saving for college. Consider setting up a 529 plan when your children are first born, even if you are doing small levels of contributions, because they can grow tax-free and reach large dollar amounts.

Matt Keefer has more than 15 years of public accounting experience. His responsibilities include preparing and reviewing income tax planning for corporations, partnerships, individuals and not-for-profit organizations, responding to federal and state tax notices, tax planning for high net worth individuals, and representing taxpayers before the IRS and state governments.

 About Gorfine, Schiller & Gardyn

Gorfine, Schiller & Gardyn is a Maryland-based full-service certified public accounting firm offering a wide range of accounting and consulting services to clients of all sizes. Gorfine, Schiller & Gardyn employs the traditional business practices of a small company, delivering solid advice and solutions, and providing unparalleled client service. One of the greatest assets Gorfine, Schiller & Gardyn brings to its clients is a team of experts trained to the highest industry standards. As problem solvers with an entrepreneurial drive, Gorfine, Schiller & Gardyn associates are committed to the success of their clients’ businesses. For more information, click here.