Business - Personal Finance Overlooked tax credit can repay $2,500 of tuition

By Dave Carpenter AP Personal Finance Writer CHICAGO (AP) -- Paying those whopping tuition bills for the fall semester doesn't have to be quite as painful as many parents of college students think. A temporary tax credit that is scheduled to expire at the end of this year can ultimately cut the cost by as much as $2,500 if certain educational expenses are paid out of pocket instead of from a Section 529 college savings plan. That's free money, worth even borrowing more cash for in order to claim it at tax time. The American Opportunity tax credit is the most noteworthy of at least three ways tuition-paying families can get some relief when they file their taxes. First, though, they must be sure their payments qualify. Many families overlook the education tax benefits, according to Mark Kantrowitz, a college financial aid expert and publisher of FinAid.org. That can be a costly omission. "Having three education tax credits can be really confusing for families," he says. "But they need to learn about it just so they can strategize and get the most out of their money." Here's a look at the major ways to save on taxes in paying college costs: -- American Opportunity tax credit. This is an expanded version of the Hope Scholarship tax credit, good for the 2009 and 2010 tax years only unless extended. It was created last year as part of federal legislation designed to help propel the economy out of recession. You qualify by paying directly for up to $4,000 in tuition, fees and course materials expenses, with a tax credit on 100 percent of the first $2,000 and 25 percent of the second $2,000. A tax credit reduces the taxes you owe, versus a tax deduction which reduces your taxable income. It's important to note that you won't qualify for this credit on expenses paid for with money from a 529 plan. That's because those plans already provide separate tax advantages. You can, however, use student loans to pay for the expenses. The maximum credit of $2,500 is $700 more than what was available under the old Hope credit, book costs are now included, and more students from middle-income families are eligible. It also is temporarily available to students for the first four years of college, not just the first two. Students must be enrolled at least half-time. The credit begins phasing out for individuals whose modified adjusted gross income is more than $80,000, or $160,000 for married couples filing jointly. Kantrowitz recommends that families try to at least pay the first $2,000 out of pocket, and ideally $4,000. "This year it's clearly the best education tax benefit," he says. Full details are at http://tinyurl.com/268ae9h. -- Lifetime learning credit. Those not eligible for the American Opportunity credit, such as undergraduates in their fifth or sixth year of study, students attending school part-time and graduate students, may instead seek a lifetime learning credit of up to $2,000. Income limits are stricter. The credit amount is phased out if your income is more than $47,000 as a single taxpayer or $94,000 if you file a joint return. The maximum income to get even a reduced credit is $57,000 filing single or $117,000 filing jointly. Taxpayers may not claim both the American Opportunity and the lifetime learning credits for the same student in the same year. The Internal Revenue Service offers a primer at http://tinyurl.com/2g6f6xl. --Tuition and fees deduction. Also available is a deduction of up to $4,000 for eligible tuition and fees for higher education. This isn't as good as a tax credit. A deduction reduces the income on which your tax liability is based. And there are income limits. But at least you don't have to itemize to take it. If you take this deduction, you can't also take one of the above credits. -- Other tax benefits: 529 plans or prepaid savings plans aren't something to set up at the last minute before writing tuition checks. But over the long haul, they offer great income tax breaks. Contributions are not deductible on federal tax returns, but your investment grows tax-deferred and withdrawals to pay for college costs are free from federal taxes. Another way to reduce the cost of going to college is to take a deduction of up to $2,500 for interest paid on student loans. The income limit is $75,000 for individual taxpayers and $150,000 for those filing jointly. Published: Wed, Jul 21, 2010

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