College Tax Benefits 101

Make Sure You're Getting Every Tax Break You Deserve

College Tax Benefits 101
September 29, 2014

The continuing increase in higher education costs has families scrambling to find the means to send their kids to college. While there are many things that you can do on the front-end to supplement college costs — such as scholarships and grants — don't forget about the back-end tax advantages that are also available.

Some people overlook these through sheer ignorance. However, the main reason education tax credits and deductions go unclaimed is because optimizing them is not straightforward. There are two main sources of complexity.

  • Status of Scholarships and Grants – Are the scholarships considered taxable income or non-taxable income? That depends on a host of things, but primarily it is how they are spent and whose tax return is being referenced (student’s or parent’s form).

    You may have some choice in allocating part of your grant/scholarship to tuition, fees and books (considered non-taxable income) and another part to living expenses (considered taxable income). Many students and parents do not realize that they have a choice, and that this choice affects their taxes.

  • Interaction – There are limitations and restrictions in the tax code that are designed to prevent receiving double benefits and to shift benefits toward the most needy (through disqualifying income limits). This is reasonable, but makes it difficult to optimize your benefits unless you calculate dummy tax forms for all the possible scenarios.

    For lower income families, there are further concerns with how the classification of income may interfere with the Earned Income Tax Credit.

Often people just choose a path and hope for the best. According to a fact sheet released by the Treasury Department, the nearly nine million students who receive Pell Grants are leaving hundreds of millions in unclaimed credits on the table each year.

IRS Publication 970, Tax Benefits for Education, summarizes all of the options available to you and goes over the rules and qualifications in detail. An online summary is also available at This site provides a link to an interactive Tax Assistant to help you determine what you are eligible for – but unfortunately, it cannot help you to optimize your choices.

There are two forms of tax relief – deductions that reduce your taxable income for the year, and credits that directly reduce the tax that you will pay. Education costs are unique in that they can be claimed as either a credit or a deduction, depending on for which you qualify. Almost always, you are better off taking a credit rather than a deduction.

The two primary credits available are the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Those who do not qualify could consider the Tuition and Fees Deduction – assuming it continues for 2014. It was allowed to expire and action to renew it retroactively is stalled. Even though the IRS still lists it on the website and contains instructions on how to use it, it may not be available to you for the 2014 tax year.

Assuming the Tuition and Fees Deduction is toast and you qualify for a tax credit, the key decision becomes how you allocate grant money.

The flyer at discusses the interactions and gives examples of how families can be affected by their choice. Unfortunately, in the end, you will still have to do your taxes several ways to optimize your benefits.

The IRS pages cover other benefits that may be available, such as the Student Loan Interest Deduction, employer-provided education assistance, and business deductions for educational expenses that are work-related. Check Publication 970 and the website to make sure that you are aware of all the benefits that could apply.

It is always possible that Congress could act and change some rules, especially in an election year. However, your greatest benefit will most likely come from exploiting whichever tax break you qualify for, and the best allocation of scholarship money between taxable and non-taxable uses – especially if you are in the lower income brackets that need it the most.

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