The U.S. Internal Revenue Service (IRS) provides tax credits and deductions for education expenses paid for post-secondary education. As the new school year starts, U.S. parents should be aware of these tax saving credits and deductions in order to maintain the records necessary to substantiate the education expenses and tax credits claimed on the tax return.
In this article, we have summarized the education tax credits available in the U.S., and the type of education expenses that qualify for tax deduction.
U.S. Tax Tips for Students
What Education Expenses Qualify for U.S. Tax Credits & Deductions
Expenses that qualify for U.S. student tax credits and deductions should be tuition and/or education-related expenses. That is expenses required for enrollment or attendance at eligible post-secondary institutions.
Student activity fees and expenses for course-related books, supplies, and equipment also qualify as education expenses. The fees and related expenses needs to be paid to the institution as a condition of enrollment or attendance.
Education Tax Credits
The following are two education credits available to students:
AMERICAN OPPORTUNITY TAX CREDIT (AOTC)
Taxpayers can claim up to $2,500 as an AOTC for qualifying education expenses in the first four years of post-secondary education. Consequently, the post-secondary school must be a qualified education institution.
Additionally, up to 40% ($1,000) of the tax credit is a refundable credit. Meaning that the taxpayer may be able to receive this amount from the IRS even if they have no tax liability. In addition to the expenses listed above, qualified expenses for AOTC purposes also include course materials. The student taxpayer can obtain Form 1098-T from their qualified educational institution to be eligible for AOTC.
LIFETIME LEARNING CREDIT (LLC)
With this Lifetime Learning Credit a taxpayer can claim up to $2,000 of qualifying expenses. However, this credit is NOT a refundable credit. This credit equals 20% of a maximum of $10,000 of qualifying education expenses.
Unlike AOTC, this credit is claimed for any number of years and the student does not need to be pursuing a degree. It is available for classes based around learning or improving job skills.
These credits are subject to income limitations and may be reduced or eliminated based on the individual’s income. Only one of these credits may be claimed per student, per year. The individual can claim the credits for themselves, spouse or a dependent that the they claim on their tax return.
If the student can be claimed as a dependent the parent’s tax return, the credit MUST be claimed by the parent.
Tax Deductible Education Expenses
Taxpayers may be unable to use the education tax credits above. If this is so, there are educations expenses targeted towards undergraduate, graduate or postgraduates. These costs may qualify for the “Tuition and Fees Deduction”. The maximum deduction is $4,000, which phases out as the taxpayer’s income level increases.
Paid Student Loan Interest
As interest incurs on one’s student loan, it can be claimed as a deduction on their income tax return. However only up to $2,500 can be claimed. This deduction is phased out for higher income paying taxpayers. Individuals being claimed as a dependent by a parent paying for the loan may not be able to claim interest on this expense.
Student taxpayers should keep in mind that any forgiven student loan amount is considered income for tax purposes and therefore must be reported on one’s annual income tax return.
Tax Qualifying U.S. Accounts Used To Pay For Education Expenses
Students can consider utilizing their 529 plans (Qualified Tuition Plan) and Coverdell Education Savings Account (ESA) if available to pay for authorized education expenses such as: books, computers, and other similar expenses.
529 Plans and Coverdell ESAs are qualified accounts in which the money is saved after-tax but any income earned by the account is tax-free provided it is utilized to fund education expenses.
In addition, distributions taken from an IRA will not be subject to the 10% additional tax. This is if the account is used to pay for qualifying education expenses for oneself, spouse or dependent. If the IRA withdrawal is taxable, it will be subject to tax rate levied on regular withdrawal.
Taxation of U.S. Scholarships & Grants
A scholarship or fellowship grant is tax free. This can be if you are a candidate for a degree at an eligible education institution and the scholarship or grant was used for qualified education expenses. Scholarships and funding received for paying for room and board are not tax-exempt. Therefore, scholarships should be reported on the taxpayers annual income tax return as income.
U.S. Students Working Part-time, Paid Internships, etc.
Students working a part time job or a paid internship will be taxed on the income received. Some will even be withheld for tax purposes. Some students will be receiving a W-2. Furthermore, filing their annual tax return is highly recommended. Even if ones income is small, the taxpayer can claim a refund on the amount withheld. Remember that all earned income, tips and “odd jobs” are re portable on one’s U.S. tax return.
U.S. State Residency & Taxes
Student taxpayers may also be subject to state taxes. Students that live in one state while attending University or College in another state, he/she may be subject to state taxes. We recommend for students to visit the state’s website and go through the residency rules. They should inquire from their school authority if they can assist or seek the advice of a tax professional.
U.S. Taxes for Non-Resident Students
“Aliens” temporarily present in the United States as students, trainees, scholars, teachers, researchers, exchange visitors, and cultural exchange visitors are subject to special rules with respect to the taxation of their income. Even though these types of taxpayers may pass residency tests. They are not considered “present” in the U.S. when they are temporarily in the U.S. for education purposes. These taxpayers are usually considered “non-resident aliens” for tax purposes. Filing of a Form 8843 is necessary to claim this exception even if the person does not need to file a U.S. tax return.
However, non-resident alien students and scholars have to file a tax return (1040NR) if he/she receives:
- A taxable scholarship or fellowship. Filing is not required when the scholarship or grant is tax-free (see above).
- Income partially or totally exempt from tax under the terms of a tax treaty; and/or
- Any other income, which is taxable under the Internal Revenue Code.
Foreign students who hold a student visa but work on part-time basis, will be subject to U.S. taxes on the income earned as it will be considered U.S. sourced. This mean a U.S. tax return will need to be filed. It is important to keep in mind that the income may also be reportable in one’s resident/citizen country. If you are unsure or need further assistance with this, please give us a call and we would be happy to help.
Consequently these are just some of the important aspects that student taxpayers should keep in mind. As time passes, income and expenses increase and tax situations become more complex. With various income from savings and even purchasing a home, tax responsibilities can further widen. Therefore, starting off early helps to slowly build up one’s tax expertise and improve one’s tax knowledge to help taxpayers become tax compliant.
AG Tax LLP Can Help
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
Please contact either of our offices across Canada at 604-538-8735 (Greater Vancouver), or 780-702-2732 (Edmonton and Alberta) to arrange for an appointment to discuss your tax related queries.
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.