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Back-to-school and the related tax issues

As children and families adjust to their back-to-school routines, the IRS had a reminder about school-related tax benefits. These can help college students, graduates and families saving for future higher education costs.

As the price of higher education continues to outpace overall inflation, average in-state costs can easily be over $30,000. It is crucial to understand the credits – American Opportunity Tax Credit (AOTC), Lifetime Learning Credit (LLC), deductions and role of 529 plans.

Currently enrolled students and their parents

The AOTC is a partially refundable tax credit (40 percent is refundable) of up to $2,500. You can claim it if you, your spouse or a dependant had qualified costs while in their first four years of college. It applies on a per-taxpayer basis. This could allow parents to claim up to $5,000 if two children are in college.

A phaseout range may preclude some parents from receiving the credit. In these cases, waiving the dependency exemption could allow the student to take the credit. The credit can offset a student’s tax liability, but he or she would not receive any refundable credit.

The LLC is broader. You can claim up to $2,000 for any post-secondary schooling. No portion of this credit is refundable however.

One other helpful above-the-line deduction (meaning you do not need to itemize to benefit) allows you to claim up to $4,000 for higher education tuition as well as certain fees. Similar to the other education credits, you can claim prepaid expenses that you would have needed to pay in the first three months of the following year.

Recent and not-so-recent graduates

Do not forget you can claim up to $2,500 in student loan interest as an above-the-line deduction. This is particularly valuable in the first years of loan repayment as you pay a significant amount toward interest.

As much as it may hurt, prepaying can also reduce the term of your loan allowing you to pay less interest over the course of your repayment plan.

529 plans for families

These offer a way to plan to help a child with college tuition down the road. Each plan has rules that govern contribution limits and investment options. Earnings grow tax-deferred and are then tax-free when used to pay for higher education expenses.

Understanding what you can and cannot do with these deductions and credits is vital to avoiding IRS questions and a possible audit.

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