Back-to School Budget Blues?

Tax credits and savings plans could help with the high cost of college.

back to school budget blues

As workers are changing jobs at a record pace and considering new careers, many are deciding to return to college to prepare for their next move. Meanwhile, many students who put off attending college classes the last couple of years due to concerns over COVID or remote learning are now planning to return this fall. This combination of factors is driving admissions to unprecedented heights, with colleges in from Minnesota to Pennsylvania, California, and elsewhere seeing record high admissions and enrollment numbers.

Yet experts are predicting the costs of attending college will be higher than ever, both in terms of tuition and supplies themselves, thanks to pandemic-related increases and inflation. 

Though I can’t offer any secret strategy for keeping college costs down, I can share the following tips for lowering your tax burden at the end of the year.

American Opportunity Tax Credit: Introduced as part of the American Recovery and Reinvestment Act of 2009, the AOTC was made permanent by the Bipartisan Budget Act of 2015. This partially refundable tax credit can help students lower their tax bills by up to $2,500 per year (for expenses of at least $4,000) as they work toward their undergraduate degrees. The credit applies not only to tuition, but also school fees, books, and needed equipment. 

The AOTC has a few restrictions:

  • The credit can only be taken four times — however, they need not be taken in a row. For example, you could use it for a two-year associate degree, then return a few years later to proceed with two more years to earn a bachelor’s degree.
  • Students must be working toward degrees — the odd non-credit course in ceramics or web design won’t count.
  • Only students earning undergraduate degrees (associate or bachelor’s) qualify. In other words, K-12, graduate, or vocational students don’t.
  • Students must be enrolled at least half time. Usually this is six credits per semester, or about two courses, but check with your school to determine what’s considered half time.
  • It’s not applicable retroactively — no filing for a refund on your four-year program now that your degree is in hand. 
  • You can’t have a record of a felony drug conviction. 
  • Keep your receipts! The credit only applies to those expenses you can prove.

The credit is only refundable up to 40%, or up to $1,000, meaning that if you owe no taxes, only up to $1,000 of that credit may be sent back to you as a refund.

Like most other tax credits, there are limits based on your income: $80,000 per year (filing as a single individual) or $160,000 (marrieds filing jointly). If your income falls between $80,000-$90,000 or $160,000-$180,000 respectively, your credit will be incrementally reduced. Beyond $90,000/$180,000, you cannot receive this credit at all.

The AOTC is a great option, but what if you don’t qualify?

Lifetime Learning Credit: This credit, while much more modest than the AOTC, could help many students shoulder their school costs. With the LLC, you can claim 20% of the first $10,000 you pay toward tuition, fees, books, and supplies, for a maximum of $2,000. 

This credit is available to all students, not just those earning undergraduate degrees, and it is not limited to a certain number of years. It is, however, limited by income levels: $59,000 for individuals/$118,000 for couples. Like with the AOTC, you can receive a reduced credit if your income exceeds those limits by $10,000 or less per person, but beyond that, there’s no credit available. The LLC also is not refundable — if you have no tax liability, you get nothing back.

Concerns for Parents of College Students

Because of the income restrictions on these credits, depending on the student’s circumstances, it may make sense to file their own tax returns so as to ensure they will meet the income qualifications. 

If you plan to claim your child as a dependent, their gross income for the year must be less than $4,300. That means that even if they’ve been earning a little money walking dogs or babysitting, it’s possible that they’ve earned too much money for you to claim them as dependents. In some situations, this might be a good thing. Even if the student hasn’t earned enough to be required to file a return (the threshold is $12,400 for individuals under 65), filing a return would allow the student to claim the refundable portion of the AOTC and receive up to $1,000 as a reimbursement for school expenses.

If your child is still years away from college, take this opportunity to start saving up. Establishing a 529 college savings plan can be a great option. In this investment account, savings are used by a designated beneficiary (i.e. your child) for qualified education expenses, which include college, K-12 tuition, apprenticeship programs, or student loan repayment. The plan works similarly to a Roth IRA by investing your after-tax contributions in mutual funds and other investments, which grows on a tax-deferred basis. Appreciation is not taxed. The money can be withdrawn, tax-free, for use in paying educational expenses, which can include anything from tuition and fees to books, computers, room and board, internet access, and other materials. 

However, despite many parents’ misconceptions, contributions are not tax-deductible. And only educational expenses qualify — if you decide to cash out the money to buy a car or if your child opts not to go to college and money withdrawn from the account is subject to both income tax and a 10% penalty. There are exceptions to this: For example, if the beneficiary receives a tax-free scholarship or employer-paid tuition reimbursement or decides to attend a U.S. military academy.

Additionally, if the original beneficiary of the plan decides not to attend college, you can also change your beneficiary — for example, to a sibling, or even to an adult in the home who wants to return to school. 

If someone in your household is planning to attend college this year or in the coming years, it’s a good idea to start planning for the financial repercussions now. Schedule an appointment with us, and we can make some recommendations based on your unique financial circumstances.

In the meantime, sharpen those pencils, break in those new shoes, and have a great school year!