The Consolidated Appropriations Act of 2021 officially put an end to the tuition and fees deduction after tax year 2020. This deduction was previously an adjustment (“above the line”) for adjusted gross income (AGI) worth up to $4,000. However, below we will discuss the remaining education related-tax deductions, credits and saving incentives that are still offered.
Tax Deductions
Student loan interest - An “above the line” deduction for up to $2,500 is available for student loan interest used to pay qualified education expenses. Tuition and fees, required course materials, room and board and other necessary costs of education are all qualified expenses for purposes of the deduction. For 2021, the deduction phases out for modified AGI from $70,000 to $80,000 (unmarried) and $140,000 to $170,000 (married filing jointly).
Tax Credits
To mitigate the loss of the tuition and fees deduction, the Consolidated Appropriations Act increased the impact of the Lifetime Learning Credit. For expenses that qualify for both the AOTC and the LLC, taxpayers may only claim one of the credits. Information for claiming the education credits is provided to taxpayers on Form 1098-T.
American Opportunity Tax Credit - Provides a maximum annual amount of $2,500 per student, calculated as 100 percent of the first $2,000 in qualifying expenses and 25 percent of the next $2,000 in qualifying expenses for the first four years of undergraduate education. If the credit reduces a taxpayer’s liability to zero, then up to $1,000 (40%) may be refunded. The credit is subject to income limits: to claim the full credit, income must be below $80,000 for single taxpayers ($160,000 married filing jointly). Taxpayers cannot claim the credit if income exceeds $90,000 ($180,000 married filing jointly). Eligible expenses for the credit include tuition and fees, books, and required course materials. Students must be enrolled at least half time. Room and board are not eligible expenses for the credit.
Lifetime Learning Credit - Provides a maximum annual amount up to $2,000 per tax return, calculated as 20 percent of the first $10,000 of qualified expenses, and it is nonrefundable. Undergraduate, graduate, and job skills courses qualify. Also note that room and board are not eligible expenses. Instead of phasing out at income levels starting at $59,000 for single filers and $118,000 for joint filers, the phaseout will begin at $80,000 for single filers and $160,000 for joint filers. Higher phaseout limits will help hold the vast majority of taxpayers harmless from the elimination of the temporary tuition and fees deduction. There is no limit on the number of years a taxpayer may claim the credit (compared to the American Opportunity Tax Credit which can only be claimed for the first four years).
Tax Exclusions
Scholarship income - Amounts received from scholarships and used to pay for tuition, fees, and required course related materials can be excluded from income by college students. The scholarship must not represent payment for services. Undergraduate and graduate scholarships are eligible, and there are no income phase outs for the exclusion. However, be aware that the tax exemption for scholarships is lost if the money is used for other purposes like room-and-board or supplies. Finally, the scholarship amount can’t exceed the tuition cost.
Forgiven student loan debt - Taxpayers, regardless of solvency, are allowed to exclude from income any student loan debt forgiven from 2021 to 2025. The student loan proceeds must have been used to pay for tuition and fees, required course related materials, room and board, and any other necessary educational expenses (including transportation).
Saving Incentives
Coverdell Education Savings Account - A $2,000 contribution per beneficiary per year is allowed under the Coverdell Education Savings Account. Earnings on investments are not taxed if used for K-12 or higher education eligible expenses. Allowed contributions are phased out for taxpayers with AGI of $95,000 to $110,000 (unmarried) and $190,000 to $220,000 (married).
Qualified Tuition Programs (529 Plans) - Earnings on investments in 529 plans may be excluded from income if used to pay for qualifying education expenses. Eligible expenses include tuition and fees, required course materials, and room and board (if student is enrolled at least half time) for undergraduate and graduate education. In addition, up to $10,000 per beneficiary per year may be used to pay K-12 tuition expenses. A lifetime limit of $10,000 per borrower may be used to repay student loan principal and interest. Annual contribution limits are set by individual states. There are no AGI limitations.
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