Education expenses - look at all the options
March 20, 2011
A lot has been written about education benefits. Too many times we hear one piece of advice and latch onto that option as the best wasy to treat something for taxes. As with anything related to taxes it is INCREDIBLY confusing and has a lot of qualifiers to determine what is best. That is why almost no one tries this on paper and pencil forms anymore and so many more tax preparers get paid for this. But ultimately they are your taxes and you need to ask the right questions before signing the final form. Here are some thoughts on what to do with education expenses.
I was recently asked about the best place to claim education expenses for an MBA. The question made me think of all the different options - and there are several. The 'latch on' solution for education expense seems to be the education tax credits and they are worthwhile for many. But they have their limitations for others. So here are some thoughts to keep in mind:
1st question - did I get paid for school?
Many of us are paid to go to school - it's called scholarships. It's important to keep in mind that scholarships must be deducted from your education expenses (more on what those are below) before you consider any deduction or credit. The general rule: you can only use the expense in one place. Scholarships are not taxable to the extent that they were used for tuition and required fees. If they were greater than the tuition and fees or were specifically for living expenses, then they are income to the recipient. This alone can get confusing when looking at that 1098-T.
But what if you being paid by work to go to school. Getting paid for going to school creates a couple of issues: is the payment 'income' and where to deduct the expense. How one answers the first influences options on the second. The first question is whether one's job description requires that you get additional education. This is the criteria to determine if a payment from your employer was taxable income. The employer makes this determination. If it is required, then the income is not included on Form W-2. This is important, because if they paid and it is NOT on the W-2 as income, then you cannot take any deduction or credit for the amount that they paid (because, in effect, you didn't pay for it - they did). This is more rare, though. Assuming you are not required to add to your education and the payment WAS included on the W-2, then you have several options for deducting it. Just remember that you can only select one of these options.
Options for claiming the deduction
Education Tax Credits. These are the things you've heard about and I won't go into great detail. Credits directly reduce your tax as opposed to reducing your taxable income. The disadvantage is that the credits are limited by one's income. The American Opportunity credit allows some deductions for books. The lifetime learning credit is limited to tuition and required fees.
The tuition and fees deduction is another option. This is a 'page 1' reduction which reduces your AGI (adjusted gross income). The benefit here over itemized deductions is that AGI is used for other calculations in your return, so 'page 1' deductions are typically the best deductions. This also has income limitations and is limited to tuition and required fees, but many times this is a better option than the credits.
The one most forgotten is the work deduction. This is claimed on Schedule A as a work related expense (also requiring Form 2106 or 2106-EZ). One advantage to the work deduction is that there is no income limitationas with others. Another advantage is that you can include other expenses over just tuition and fees (the amount from 1098-T). The disadvantage is that it goes under misc. expenses on Schedule A and is subject to a 'floor' or reduction of 2% of your AGI. "Work related" is something you and maybe your employer determine. If your employer pays for it, they likely want you to have it. You can also read the links below or the 2106 instructions for more information.
Which one should you take? It depends. I don't know of anyone not using a paid preparer or tax program, which makes it easy to try all 3 to see which is best for you. Always read the instructions to be sure you are including the right amounts. Remember that any deduction is limited to what YOU pay. As discussed above, if a scholarship or employer pays for it (and it is not on the W-2), then you didn't pay. Also remember that paying with a student loan IS paid by you. And the interest you pay will be deductible on page 1 as well - but that's more qualifications!
How to Use College Tuition as a Tax Deduction http://www.ehow.com/how_2080749_use-college-tuition-as-tax.html
Tax Incentives for Higher Education http://www.irs.gov/individuals/article/0,,id=96341,00.html
Tax Topics - Topic 513 Educational Expenses http://www.irs.gov/taxtopics/tc513.html
Philip Laube is a CPA in Ohio and the Assistant Vice President for Business & Finance at Muskingum University. He presents and writes about personal finance issues for college students. He can be followed at twitter and on his web site