The Tax Perks of Going Back to School

Lots of folks are going back to school to improve their standing in today’s brutal job market, and there are some helpful tax breaks for doing so. In a recent article, I explained when you can claim the American Opportunity Credit (up to $2,500) or the Lifetime Learning credit (up to $2,000) for your own education expenses. (For now, please forget about your kids or grandkids; this is all about you.)

You can’t claim the page 1 deduction for your own tuition and fees if you claim either the American Opportunity Credit or the Lifetime Learning credit for your own expenses. No double dipping! However, you’re allowed to claim the deduction while claiming a credit for expenses incurred for your spouse or child.

You’re ineligible for the deduction if you’re married and don’t file a joint Form 1040.

Also, the IRS says you can only claim the deduction if you already have a high school diploma or GED.

Qualified expenses include tuition, mandatory enrollment fees, and course materials including books and supplies. However, the IRS says you can only deduct books and supplies if you’re required to purchase them directly from the school. And you can’t deduct optional fees for things like student activities and insurance. Room and board costs are off limits, too.

You must also be attending an eligible institution. Virtually all accredited public, nonprofit, and for-profit postsecondary schools pass this test, as well as some vocational schools. Eligible institutions are given Federal School Codes, which you should be able to verify online at www.fafsa.gov.

Finally, you can claim a 2009 deduction for qualified tuition and fees that you pay this year for courses in academic periods that begin either this year or in January through March of 2010. By prepaying tuition and fees that are due early next year before the end of this year, you could lower your 2009 tax bill.

If you’re unmarried with modified adjusted gross income (MAGI) of $65,000 or less, the page 1 deduction equals the lesser of: (1) $4,000 or (2) 100% of qualified tuition and fees. Ditto if you’re a married joint filer with MAGI of $130,000 or less ($4,000 is the maximum deduction even when both spouses have qualified expenses).

If you’re unmarried with MAGI between $65,001 and $80,000, the maximum deduction is reduced to the lesser of: (1) $2,000 or (2) 100% of tuition and fees. Ditto if you’re a married joint filer with MAGI between $130,001 and $160,000 ($2,000 is the maximum deduction even when both spouses have qualified expenses).

If your MAGI exceeds the $80,000 or $160,000 ceiling (whichever applies), you get no deduction at all. Sorry.

MAGI means “regular AGI” from the last line on page 1 of your Form 1040 increased by certain tax-exempt income from outside the U.S. and the deduction for domestic production activities. (These adjustments are rather unlikely to apply to you.)

Good question. As I said earlier, you can’t claim both the page 1 deduction and the American Opportunity Credit or the Lifetime Learning Credit for expenses incurred by the same student (in this case, you). So you have to pick Door No. 1 or Door No. 2.

If you qualify for the rather generous American Opportunity credit, it will deliver more tax savings than the deduction in any situation I can imagine. So claim the credit.

A more common scenario, however, is that you qualify for the Lifetime credit but not the American Opportunity credit. In this case, figuring whether the Lifetime credit or the deduction will cut your tax bill more can be a close call. The trade-off gets complicated because it depends on the amount of qualified education expenses, your marginal tax rate, and the whether the credit phase-out rules apply. The only sure way to find out which break is best for you is to fill out Form 8863 to calculate the credit and Form 8917 to calculate the deduction. Then complete the rest of your return to see which one lowers your tax bill the most. Pick that one.