1, 2, 3 ... The Tax Breaks for Higher Education Expenses Can Really Add Up

Thanks to the new tax extenders law passed at the end of last year – the Tax Increase Prevention Act of 2014 (TIPA) – parents with children in college have not one, not two, but three tax breaks to choose from on their 2014 returns. But some of your upper-income clients will be completely shut out.

Even if you qualify, you can only elect one of these three tax breaks for higher education on your tax return. Here’s a brief lesson.

1. Tuition-and-fees deduction: Parents may claim an above-the-line deduction for tuition and related fees paid to college on behalf of their dependent children. The deduction is either a flat $4,000 or $2,000, depending on your modified adjusted gross income (MAGI) for 2014.

If you’re a single filer, the $4,000 deduction is available for a MAGI of $65,000 or below. The deduction is $2,000 for a MAGI between $65,000 and $80,000 and then it disappears completely. Joint filers may deduct $4,000 for a MAGI up to $130,000 and $2,000 for a MAGI between $130,000 and $160,000. No deduction for joint filers is allowed above the $160,000 threshold.

The tuition-and-fees deduction technically expired after 2014, but was retroactively reinstated by TIPA to the beginning of 2014. As of now, the deduction has not been extended to 2015.

2. American Opportunity Tax Credit: With the American Opportunity Tax Credit (AOTC), parents may reduce their tax liability on a dollar-for-dollar basis, up to a maximum credit of $2,500. The AOTC is available for each student in the family. Thus, if parents have two kids in college at the same time, they may claim a $5,000 credit for 2014.

However, the AOTC is also phased out based on MAGI. The phaseout range is between $80,000 to $90,000 of MAGI for single filers and $160,000 to $180,000 for joint filers before it disappears completely. Currently, this credit is on the books through 2017.

3. Lifetime Learning Credit : The Lifetime Learning Credit (LLC), which is based on a permanent provision in the tax law, doesn’t have to be periodically extended. However, the maximum $2,000 credit is applied on a per-taxpayer basis., regardless of the number of students in school at the same time.

Also, the LLC is phased out at relatively low income levels. The phase-out range is between $55,000 to $65,000 of MAGI for single filers and $110,000 to $130,000 for joint filers. These figures are not indexed for inflatoion.

Do the math. Although each situation is different, the AOTC usually wins out. For example, suppose our parents with two children in college have a MAGI of $100,000. They can claim either a $4,000 tuition-and-fees deduction, a maximum $5,000 AOTC or a maximum $2,000 LLC. In this example, the AOTC is the clear choice.

Finally, when you provide calculations for clients, remember that a credit is infinitely more valuable to taxpayers than a deduction. In any event, help your clients make the best tax return election for their personal situation.