269. What College Expenses are Tax Deductible for Parents?

Managing college expenses can be overwhelming, but understanding available tax benefits can help parents reduce costs. Join us on this episode of A Wiser Retirement® Podcast as we discuss how these tax benefits work and what families need to know about deductions, tax forms, and financial planning for college.

Related Podcast Episodes:
- Ep 168: Everything You Need to Know About 529 Plans
- Ep 136: Financially Preparing for Your High Schooler to Go to College

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Transcript

Tax Credits for College Expenses

Speaker 1 0:00

I do remember you could deduct tuition and there's no longer a tuition deduction , Unfortunately there's not yet Right . It's looking at how much did you pay for college ? So there's really only a couple credits that you can do . Welcome to a Wiser Retirement Podcast . Are you looking for smart ways to save on college costs ? I'm Shauna Theriault and today I'm joined by Missy Beach . Each week , we bring you practical advice on retirement , investing and planning for your financial future . Don't forget to subscribe to the podcast wherever you're listening . Let's get started . Good morning .

Speaker 2 0:40

Hey Shauna , how are you ?

Speaker 1 0:40

doing today ? I am awesome . How are you Great ?

Speaker 2 0:44

What a topic .

Speaker 1 0:45

I know . Well , that's what you and I were talking about . Right , we actually had another topic slated for today and this is March 3rd that this is being produced and we keep getting questions on people getting 1098Ts , and all of you know we go through those different things in our faces . We've done it together . It's like you know , everybody was getting married and then having kids and everybody's in college , and so we keep getting these questions from clients and friends , honestly , of what do I do and how do I claim all this stuff on the tax return ?

Speaker 2 1:12

Exactly . I mean , we're getting these forms in the mail and digitally , and what is ? What do we do with them ? Right ?

Speaker 1 1:19

exactly . And it's like the questions we're getting is can I deduct tuition ? What does that look like ? Do I have to ? Because when you get your 1098-T , so that is the form that's issued from the college that shows here's how much you paid in tuition , and then , I think , box five shows here's how much you got on scholarships . So it's like do I need to claim that as income ? How do I do this ? And so we thought what a great topic , because everyone at the end of February should be getting all their 1098s and 1099s and starting to prepare for tax returns , and so they're asking a lot of questions . I feel like a lot of people are preparing their own tax returns too .

Speaker 2 1:54

You're right , everybody seems to be going that route , so it is daunting when you get this form and there's some big numbers on that form , oh yeah , how does it impact your taxes ?

Speaker 1 2:05

Absolutely , and TurboTax is actually . I'm not trying to plug it , but it's actually pretty good about walking you through all those , so anyway . So the starting question was can I deduct tuition ? I remember back in the day you could Really .

Speaker 2 2:20

Yeah , back in the day when I went to college .

Speaker 1 2:23

Back in the day . I feel like we're getting older . I do remember you could deduct tuition and there's no longer a tuition deduction , Unfortunately there's not , yeah Right .

Speaker 1 2:38

So it's looking at how much did you pay for college . So there's really only a couple credits that you can do , so I don't know if you want to go into it , Missy . The couple of the ones the Lifetime Learning Credit and the American Opportunity Credit and I feel like these have changed over time . So we have a lot of information in front of us because , as professionals , we always have to reference tax codes , right ?

Speaker 2 3:00

Exactly yes , because we are not CPAs and we are not giving all tax advice , but we are looking at this from a planning perspective , of course . Well , shawna is a CPA , but she's not preparing your tax return .

Speaker 2 3:13

That's right offset the cost of higher education . So you know , at most of our clients it's not a huge meaningful offset . You know if you're paying , you know out of state , public or private tuition . But you know every little bit helps . So yeah , let's look at them . So first of all is the Lifetime Learning Credit . So this is a little bit more flexible than the American Opportunity Tax Credit in that the Lifetime Learning Credit isn't just for college . It could be also used towards vocational training and things if your child doesn't go the traditional college route . So keep that in mind . It's a lot more flexible . But it's good towards your normal eligible expenses like tuition fees , books , supplies and other lab fees , that sort of thing . So it does have phase-out ranges , of course . So single filers it starts phasing out at $80,000 a year . Married filing jointly it phases out at around $160,000 , completely phased out at $180,000 of joint income on your tax return .

Speaker 1 4:42

Right , so that means that if your income's over $180,000 collectively , then you can't , you're not eligible for it , which is true of a lot of the credits in the tax code actually .

Speaker 2 4:51

Absolutely yeah . So I mean it's even a lot lower than , like , a Roth IRA contribution phase out range .

Speaker 1 4:57

So this is geared towards you know the lower end of tax brackets geared towards .

Speaker 2 5:01

you know the lower end of tax brackets . So a lot of our clients , unfortunately , are phased out of this . But it's worth up to $2,000 per tax return if you're within those limits .

Speaker 1 5:17

So you know , don't ignore it . And one of the things with it , with that $2,000 , it's only 20% on the first $10,000 .

Speaker 1 5:24

So in other words if you had $2,500 of expenses , you can only do 20% in that credit . So it's not a dollar for dollar . Exactly , very good percentage , yeah , and I guess this is a good segue to to talk about that . So you know , we used to be able to deduct tuition , but it wasn't above the line deduction , meaning it wasn't dollar for dollar . It would just reduce your taxable income where the credit is dollar for dollar . So if you owe $3,000 of tax and this credit is $2,000 , it'll credit $2,000 . You'll only owe $1,000 in tax . So that's better than a deduction .

Speaker 2 6:04

Yes , Credits are better than deductions . Right Any day .

Speaker 1 6:07

Right , and one of the things with this credit too , and the example I just gave you , the lifetime learning credit is not refundable , meaning that if you didn't owe tax , then you can't go and get the credit of $2,000 . So it only reduces how much you owe in tax . So again , if you owe 3,000 and you get a 2,000 credit , it would work , but if you owe nothing and you're in a really low tax bracket , it is not refundable . So , in other words , if you don't owe tax , they're not gonna give you money back for it .

Speaker 2 6:38

Zero is your bottom threshold Right right .

Speaker 1 6:41

So some are refundable and some are non-refundable . So that's what that verbiage means .

Speaker 2 6:46

Exactly so . Let's talk a little bit about the tax return and where you'll see this . So this is form 8863 , education credits is where you're going to see it on your tax return . If you're doing TurboTax , it's going to ask you that nice little question but you're going to see the actual output on that form 8863 . And you're going to use that form 1098-T to use as your input numbers . That'll get it there as your end result .

Speaker 1 7:19

Absolutely

Educational Tax Credits and Scholarships

Speaker 1 7:20

. And so the other credit that works somewhat similarly but has a little bit different , that's the American Opportunity Credit .

Speaker 2 7:28

Right , shawna , and unfortunately you can't have it both ways , so you're going to have to pick or choose .

Speaker 1 7:33

Right , you can't use both of them for the same student or beneficiary in the same year .

Speaker 2 7:39

Exactly , and this one is a little bit stricter on eligibility requirements . This is just for more your college track normal path , so you can't use it for vocational or more you know more non-standard path kids .

Speaker 1 7:57

So you have to be working towards a degree .

Speaker 2 7:59

Exactly One tidbit here your child can't have a felony drug conviction . Okay , we hope that's the case anyway . Right , that's what we all hope .

Speaker 1 8:12

So it has the same phase out limitations , meaning if you make over $180,000 , you cannot have the credit . So it's very similar to that , but the difference here is that it's up to $2,500 .

Speaker 3 8:28

Yes .

Speaker 1 8:30

And what percentage is it ?

Speaker 2 8:32

Oh yeah , so it's phased a little bit differently . So it's 100% of the first $2,000 of tuition paid and then 25% of the next $2,000 .

Speaker 1 8:49

paid and then 25% of the next $2,000 . Okay , so if you have expenses of $2,000 , then you're eligible for $2,000 .

Speaker 2 8:53

And then anything above that is 25% up to , I guess , the $500 mark , yeah , so it seems like that's a little bit more of an easier bar to cross versus just going 20% of your whatever tuition paid , versus of the lifetime learning credit .

Speaker 1 9:10

And so it seems that because it's a better value , potentially , you can get more dollar for dollar versus a 20% up to 10,000 . And you know , maybe that one is a little better to use potentially because you may get more depending on what the dollar amount is . Yeah , I mean , it's twenty five hundred to exactly .

Speaker 2 9:30

So you just have to do the math Exactly , this one is refundable .

Speaker 1 9:36

I know not one hundred percent , A certain percentage is refundable , but this one is refundable . So in other words , you know , if you owe zero , I believe you can get up to 40% of the credit as a refund . I believe is what the rule is Don't quote me on that but I believe it's 40% . So it's not 100% of it , but you can get a portion . So even if you owe zero , you still can get some back . So that's partially refundable . So really , those are the only two credits available . So if you think about how much you pay in tuition and it just reduces your taxable income , that is still really strong . That it's credits . But a lot of people , a lot of Americans , are phased out of that .

Speaker 2 10:16

Yeah , so if you're making more than $180,000 and you're filing jointly , this is off the table for you .

Speaker 1 10:23

Yeah , yeah .

Speaker 2 10:24

Or singles , you know , filing what ? 80 or sorry , $90,000, . You're out of the phase out range as well , Right I ?

Speaker 1 10:33

guess that's even more reason to do a 529 . Yeah .

Speaker 2 10:37

I would agree .

Speaker 1 10:37

Because you don't get the deduction anyway . And so if you're saving when they're younger and you start when they're younger , you have that time value of money where it has time to grow a little bit and earnings are tax free . And then when you take distributions , then they're tax-free as long as you use them for higher education expenses . So if you think of the end in mind and you think , okay , this is of course they could always change the tax code , but there's not really any tax benefit here if you're in a higher bracket . And so if you're in a higher bracket , I suspect hopefully you're saving and you could put more in 529 and do it that way and use that as the tax advantage .

Speaker 2 11:20

Exactly , and these tax credits evolve over time too . You know , they come , they go , limits change , phase outs change , so I wouldn't anchor your education savings plans on these two tax credits .

Speaker 1 11:34

Yeah , well , and so basically the other question we get is on that box five , you know , are the scholarships taxable ?

Speaker 2 11:43

Oh yeah , it's like it's looming out there .

Speaker 1 11:47

It's looming out there . You know , is it ? What do I do with that big number ? And hopefully , hopefully , you have a big number for your child and they did well and they did get you know scholarships . So what do you do with that ?

Speaker 2 12:03

Well , that's the great thing . Scholarships are generally tax free as long as it's used towards the tuition .

Speaker 1 12:11

Yeah .

Speaker 2 12:12

I would say 99 percent of the cases . All your tuition that's being offset by scholarships is fine . So I can't think of some rare instance where it might be used for non-qualified expenses . Maybe if you go off on some boondoggle program that's not a qualified institutional expense , then maybe some of it would be taxable . But no , your scholarship , you're all good . That is not taxable income on your tax return .

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Tax Credits and Child Tax Credits

Speaker 1 13:35

Now let's get back to the episode , yeah , and so I did read and I don't know how the calculation exactly works , but it , can you know , help offset the credit too . So it's like if you had a scholarships it could reduce your credit as well . There's a calculation . I don't know the calculation offhand , but I do know that you know once you enter scholarships it could , you know , further reduce your credit as well .

Speaker 2 13:59

Well , that makes sense , because you were not paying that tuition out of pocket , exactly . The school was giving you that money , so that reduces your tuition .

Speaker 1 14:08

Yeah , so I mean it's not taxable per se , but it could reduce your credit of getting taxes back , you know . So it kind of is taxable in that way a little bit , but we love scholarships .

Speaker 2 14:21

Absolutely Don't worry about that ruining anything .

Speaker 1 14:25

Yeah , and there's also , you know we get questions . You know how does this work with the child tax credit and the child tax credit , that is , you know , a credit that's up to $2,000 per child that all of us can file , depending on your income . Again , if it's married filing jointly , $400,000 is the threshold , but that's really , you know , under 17 years , so you know . So it's like . The question is should I claim my child or should they claim themselves ? I mean , you're supposed to claim your child if you supported them , right , but the reality is the way that the tax code used to read is we used to have all these deductions for dependents and all of this , and it doesn't . We don't really have that . We have this child tax credit up to 2,000 per child , but they have to be under 17 , yeah , I know .

Speaker 2 15:09

And so those are not your college kids ?

Speaker 1 15:11

no , traditionally no they're not and there's some other dependent credit that's like 500 that they they may qualify for , but we really don't have that deduction anymore . So you know it's like we get questions all the time Should my child file their own tax return ? Well , maybe , and there's some rules where they need to . But you know I mean technically you're supposed to file and you know you're supposed to claim them as a dependent if you are supporting them more than half the time . Now there are situations and we do get this question some when should they file their own tax return ? So there are specific situations . In situations where they do need to file , it doesn't mean they're going to owe tax , but they may need to file their own tax return .

Speaker 2 15:57

Right . Well , if they've had some Mac Daddy summer job as an internship , maybe they have really high earned income that exceeds the threshold , which for last year , if they're filing the return now , is more than $14,600 . Or if you have an investment account for them and their unearned income is greater than $1,300 .

Speaker 1 16:21

So that would be like a custodial account or a brokerage account , right , exactly . And so dividends interest , capital gains , and so that's that unearned income on the portfolio . And so if they have over $1,300 , then they have to file their own tax return .

Speaker 2 16:36

Yes , or this one . You know you don't think of self-employment income greater than $400 . Right , Like that's a very low bar .

Speaker 1 16:48

Yeah , it is , and that's just . I think that I'm assuming that's because they would have to file like Medicare and Social Security taxes .

Speaker 2 16:54

That doesn't mean they owe tax . No .

Speaker 1 16:56

But I mean , I guess they would owe self-employment tax in that regard . A little bit maybe . Yeah , A small amount , I know too . Um , sometimes you may have to file a tax return . So if they do have a summer job , some of the jobs will do federal and state withholding and some won't . And so if they did federal state withholding and your child doesn't owe tax , then you have to file an informational tax return to get the refund back .

Speaker 2 17:23

Exactly , even if it's a small amount of money .

Speaker 2 17:25

Well , yeah , they want their $50 because they worked hard for that . Exactly , shawna . So it all depends , when your kid goes for a summer job , how they fill out that W-4 . So my kids learned the hard way and so they had withholding taken out , albeit a small amount , and we had to file and get it back . But then now they've been trained , they file no withholding and you can do that as a child and so you can have zero withholding withheld . Yeah , and that way you don't have to go through the gymnastics of filing this piddly little return to get your $50 back .

Speaker 1 18:05

Yeah , you don't want to pay a CPA or TurboTax to do that , but you you actually can do a free one online , um through free tax USA or something like that , where you can just file simple 1040 just to get the refund back .

Speaker 2 18:21

That's a great tip . Yeah , don't pay money to get $50 back . No , it's very simple .

Speaker 1 18:27

I remember back in the day when I was 16 and I had my first job . Back in the day it was 30 years ago , I sound really old . So you know , back in the day I would go to the library and I would get the paper to fill out and manually do my tax returns .

Speaker 2 18:42

So you would go to the library and had the instruction booklet and then it had the forms From the cardboard box in the library . I know what you're talking about .

Speaker 1 18:49

That was awesome and so actually that's how I learned how to do tax , because it was like , oh , you fill out , yeah Go to the table , yeah , and you had to manually fill out your form and it made sense .

Speaker 1 19:00

So I mean you can even . It's simple . I don't think they have them in the libraries anymore , but they have them online where you could do that and just type it in . It's very simple , just to get their refunds . So you know it's worth doing it and it's really fun . Actually , you know both of my older girls they have jobs and so this year we looked and they didn't do the withholding again . So I'm like , good , we don't have to file the return to get the $26 back from the feds , which is fun . But you know they're both like , wait , what are tax forms ? And I love talking to them about this because it's like , okay , we have to file tax returns for you . You know , you have your investment accounts . Now we have 1098T for my oldest and so I'm talking about all these boxes . So it's good to bring them into the conversation .

Speaker 2 19:41

Oh , absolutely . It's so educational and you know , like , why they don't owe tax . Okay , Cause you're below this threshold . But if you start earning more than 14 , six , well then we have another conversation .

Speaker 1 19:54

Yeah , but you're right .

Speaker 2 19:55

Like don't just do it for them ?

Speaker 1 19:57

Yeah , Get them involved . I love it . And then also I know many parents do this too where you can look at their earned income on their W-2 and you can put that much into a Roth 401k up to 7,000 . So the Roth IRA that's what I meant , sorry . Yes , up to 7,000 , but not over the earning . So in other words , if they earn $1,200 , you can put $1,200 into a Roth IRA .

Speaker 2 20:23

Oh , that's what we do with our boys . We talk about okay , so this is how much you made . We know you've spent a bundle , but what's left over ? And then we do the power of compound interest . Okay , you're in an aggressive portfolio because you're , you know , 19 years old or 22 years old . Let's look at how much it's going to be when you hit retirement . Then they're like oh well , maybe I could put a little bit more in my Roth IRA you know Love it .

Speaker 2 20:52

So when you show them the power of investing at such a young age , it helps them be a little bit looser with their Roth IRA contributions , oh yeah .

Speaker 1 21:02

With their own money . Oh , absolutely , and it helps them from spending too , although they don't have problems spending the parents' money . Usually , it's just , you know , if it's their money , it's like wait a minute , that's expensive . But yeah exactly .

Speaker 1 21:15

You know that's good , it's good that you're having those conversations , for sure . And so , going back to the other thing is the 529 and how to report that . And so if you're making contributions to a 529 , maybe they're not in college yet and you're making contributions you're not going to get a tax form showing a contribution . It's not like when you make a contribution to an IRA and you get that $54.98 , you don't get a form . No , so in some states , depending on your state , there is a state tax deduction if you have a 529 set up in your state . So you know , in Georgia we have a state . So if you're in the Georgia 529 , we can get a state tax deduction for that . So you just have to track it . You can look at your last statement of the year and in the 529 and show , okay , this is how much was contributed and you know , apply it to your Georgia , your tax return in your state , If you have that .

Speaker 2 22:12

It's so many people forget to do that , shauna , because you're right , there's no form at tax time that they get reminding you . Hey , I put 8,000 in my Georgia five 29 .

Speaker 1 22:24

Right , give me a little credit for that Right , it's not huge , but it's it's still . You know , it's still something . It's . It's saving some tax . Now , the distributions that you get if you take them out for expenses you will get a tax form for that and so you just have to , you know , figure out what is taxable and not taxable and all of that , and some of it may be on your tax return and some of them might not , but you will get a tax form for that . So it's imperative that you keep records showing what it was for . You know , just throw it in your tax file Usually it's tuition or you know room and board books , et cetera and just keep that in your tax file to back it up .

Speaker 2 23:05

Yeah , and it's interesting that you don't have to report it on your tax return if it was used for qualified expenses . So you just , like you said , keep it as backup , I mean just like your charitable donations , like keep it as backup . You know you're putting that on your return , but yeah , just have a little backup , yeah .

Speaker 1 23:21

CYA , absolutely Well . I think that is probably everything having to do with scholarships , tuition , student loan interest oh , we didn't address student loan interest actually . So student loan , this is kind of after the fact . So some people decide to take out student loans . Now there's a portion that may be accruing interest while you're in school and a portion that's not .

Speaker 1 23:46

So there's based on you know , you fill out the FAFSA and , based on your eligibility , you may get a student loan . And then if you take that student loan , then there may be a portion that is subsidized versus non-subsidized . So subsidized means , and that percentage is based on a whole calculation based on your income and assets and other things , and so a portion may be subsidized versus unsubsidized . The subsidized portion does not accrue interest while you're in school . The non-subsidized does . So there is it's again really small . Now this is a deduction , it's not a credit . Exactly so you can deduct up to $2,500 a year of your student loan interest . Now the income is , you know , one night for married filing jointly , any anybody above one 90 is phased out completely . You can't deduct it .

Speaker 2 24:42

Of course it has its own phase out limits , right .

Speaker 1 24:45

Right and it's actually on the front of 1040 and it's above the line deduction , just like the tuition used to be . So it used to have both there . But now it's just student loan deduction , student loan interest deduction , so it's a max of 2,500 , but then the single above 9,500 and married filing jointly 190 . So again , if you , if you fall below the 80 or the 160 , then you could potentially deduct up to 2,500 of that , so I would still track it . You're going to get a tax form for that . It's going to show how much you paid in interest . So I would still track it . You know , every year put it in the tax file , whether you get it or not , give it to your CPA or enter it and it's going to tell you . The program is going to tell you if you're doing your own taxes , whether you can deduct it or not .

Speaker 2 25:31

Yeah , enter everything . Yeah that's the name of the game yeah , I mean it doesn't hurt to enter the data and then they'll tell you if it's a no-go . Exactly yeah , and that's the 1098e form that you get from the student loan interest yeah .

Speaker 1 25:47

So again , you know you may have to get all these forms from your child , because that's what you know . I was like send me your 1098t and send me your W-2s and all of that . So they have logins , but we don't .

Speaker 2 25:58

That's the scary thing , isn't it , shawna ? Like relying on your young adult to relay the information , yeah , but it's teaching them , it's teaching them To adult .

Speaker 1 26:08

Exactly to adult that you have to keep up with this so well . Thank you for listening today . We actually have other episodes , if you're interested . Episode 168 , everything you need to know about 529 . So it'll go into depth there . And then episode 136 , financially preparing your high school to go to college . That may be a good one to listen to . Thank you for listening to today's episode . If you're interested in learning more about Wiser Wealth Management or wanna schedule a consultation to meet one of our fiduciary financial advisors , or want to schedule a consultation to meet one of our fiduciary financial advisors , you can do so by going to wiserinvestorcom or you can click the link in the episode notes .

Speaker 3 27:10

We'll see you next week . Thank you . Financial products , securities , digital assets or any other investment vehicles or a basis to make any financial decisions . Wiser Wealth Management Incorporated is a registered investor advisor with the SEC . The host and or guests may personally own securities , digital assets or other investment vehicles mentioned on this podcast . Neither the host nor guests of the show are compensated for their participation and no referral fees are paid to or received by any host or guest for clients , listeners or similar interests . Investments involve risk and unless . Thank you .