How to offset college costs with education tax credits

Education tax credits help offset the cost of higher education by reducing the amount of tax you owe to the IRS. (Shutterstock)

College is expensive. Fortunately, you have several ways to offset the costs, from comparison shopping for the best rates on student loans to using tax breaks to offset education expenses.

If you’re faced with covering the cost of higher education, here’s what you need to know about education tax credits and other education-related tax breaks.

Education tax credits can help defray costs while you’re in school. But if you’ve already graduated and are looking for a lower interest rate or smaller monthly payment, private student loan refinancing can be worth considering. 

Credible makes it easy to see private student loan refinance rates from multiple lenders.

• What are education tax credits and how do they work?
• Education tax credits to know: American opportunity tax credit
• Education tax credits to know: Lifetime learning credit
• How can I claim an education tax credit?
• Other ways to offset college education costs

What are education tax credits and how do they work?

You’re likely familiar with tax deductions, such as the standard deduction or the mortgage interest deduction. The value of a tax deduction depends on your tax bracket. For example, if you’re in the 24% tax bracket and take a $1,000 tax deduction, you shave roughly $240 off your tax bill.

Tax credits are more valuable because they reduce the tax you owe, dollar for dollar. For example, if you owe $1,000 in tax but can claim a $1,000 tax credit, your tax bill is zero.

Refundable tax credits are even more valuable because they can create a tax refund. For example, if your tax bill is $1,000 and you can claim a $2,000 refundable tax credit, you’d receive a $1,000 refund.

Two main federal education tax credits are available, and your ability to claim these credits depends on multiple factors, including the amount and type of college expenses you had during the tax year, your level of enrollment, and income. Depending on where you live, you may also qualify for state-level tax credits.

Education tax credits to know: American opportunity tax credit

The American opportunity tax credit (AOTC) is worth a maximum of $2,500 per student.

It’s a partially refundable credit, meaning if it brings the amount of tax you owe to zero, you can have up to $1,000 of the credit refunded to you.

Qualified education expenses for the AOTC include tuition, required fees, and course materials needed for attendance.

The American opportunity credit is the more generous of the two federal tax credits for education, but it also has the strictest requirements. To claim the credit, you, your spouse, or your dependent must:

• Be enrolled at least half-time and pursuing a program that leads to a degree or credential
• Be in the first four years of undergraduate education (for example, freshman through senior year of college, but not graduate school)
• Not have any felony drug convictions

The AOTC also phases out if your income is too high. To claim the full credit, your modified adjusted gross income, or MAGI, must be $80,000 or less ($160,000 or less if filing a joint return). If you’re single with MAGI between $80,000 and $90,000, or married with MAGI between $160,000 and $180,000, you can claim a reduced credit. If your income is above those upper limits, you can’t claim the AOTC at all.

Education tax credits to know: Lifetime learning credit

The lifetime learning credit (LLC) is worth up to $2,000 per return, and no portion of that is refundable.

The definition of qualified expenses for the LLC includes tuition and required fees. But it only covers course materials, such as books, supplies, and computer equipment, if the cost of those materials must be paid to the college or university as a condition of enrollment or attendance.

The LLC isn’t limited to the first four years of higher education and doesn’t require the student to be enrolled at least half-time or pursuing a degree. This makes it available to graduate students and people taking college courses to improve their job skills.

For the 2021 tax year (returns filed in 2022), your MAGI must be below $80,000 ($160,000 for joint filers) to claim the full LLC. If your MAGI is between $80,000 and $90,000 ($160,000 and $180,000 if filing jointly), then your credit is gradually reduced. You can’t claim the LLC at all if your MAGI is above those upper limits.

Eligibility for tax breaks is often tied to income. But income requirements for refinancing your student loans may be more flexible. If you’re considering refinancing your student loans to save money, you can compare rates from multiple lenders using Credible.

How can I claim an education tax credit?

You should receive a Form 1098-T from your school around the end of January following the year you paid qualifying expenses. You can use Form 1098-T to claim one or both education tax benefits by completing Form 8863 and filing it with your tax return. 

Just keep in mind that you can’t "double-dip." For example, if you claim the AOTC for yourself or one dependent child, you can’t claim the LLC using the same student’s education expenses. 

Other ways to offset college education costs

Education credits aren’t the only way to make college more affordable. Consider these strategies to help lessen the financial burden:

• Student loan interest deduction — If you take out loans to pay for college, you can deduct up to $2,500 of student loan interest paid each year. But your deduction may be gradually phased out or eliminated if your MAGI is over $70,000 ($140,000 if married filing jointly).
• Federal Direct Consolidation Loan — If you have federal student loans with several different loan servicers, a Federal Direct Consolidation Loan can simplify repayment by combining them into a single loan with one monthly payment. Although it’s not guaranteed that you’ll get a lower interest rate, consolidating may reduce your overall interest rate or allow you to save by switching variable-rate loans to fixed-rate loans.
• Income-driven repayment plan — An income-driven repayment plan helps make your monthly student loan payment more affordable by basing it on your income and family size. Depending on the type of repayment plan you’re under, you may be able to have the balance of your loans forgiven if they aren’t fully paid off at the end of 20 or 25 years. But an income-driven repayment plan won’t lower your interest rate or costs.
• Private student loan refinancing — Refinancing your private student loans can also help lower the cost of college if you’re able to secure a lower interest rate. Just keep in mind that refinancing federal student loans into a private student loan means losing your access to federal loan benefits, like income-driven repayment plans and student loan forgiveness programs.

You can learn more about private student loan refinancing, and compare rates from multiple lenders, by visiting Credible.