Tax and Savings Benefits for Students and Families

Tax and savings benefits for higher education

Tax-free treatment of scholarships and fellowships
Hope credit
Lifetime learning credit
Tuition and fees deduction
Student loan interest deduction
Traditional and Roth IRA withdrawals
Coverdell Education Savings Accounts
Qualified Tuition Programs (529 Plans)
Employer-provided tuition assistance
Education savings bond program

Tax-free treatment of scholarships and fellowships

According to the Internal Revenue Service, in general, scholarships and fellowships are tax free — including Pell Grants, Fulbright Grants, veterans' benefits, and other Title IV need-based education grants — if the following two requirements are met:

You are a candidate for a degree at an eligible educational institution, and
You use the scholarship or fellowship to pay qualified education expenses, including tuition, fees, books, supplies, and course-related equipment and expenses.

Note that any portion of a scholarship or fellowship used to pay for room, board, travel, research, clerical help, or equipment not required for enrollment is taxable.

Funds received for teaching, research, or other services under the National Health Service Corps Scholarship Program or Armed Forces Health Professions Scholarship and Financial Assistance Program are not taxed.

For more information, see IRS Publication 970, "Tax Benefits for Education."

Hope credit

During the first two years of postsecondary education, parents of dependent students or independent students who are not claimed as an exemption on their parents' tax return may qualify for a Hope tax credit of up to $1,650 per student per year for tuition and related expenses. Here are the highlights:

The tax credit equals 100% of the first $1,100 of tuition and fees required for enrollment and attendance (not room or board) and 50% of the next $1,100 paid during the applicable tax year to an institution that participates in the U.S. Department of Education student aid programs.
To qualify, the student must have earned a high school diploma or equivalent degree, be enrolled at least half time for one academic period during the tax year, and must not have been convicted of a federal or state drug felony.
The amount of your Hope credit for 2007 is gradually reduced (phased out) if your modified adjusted gross income (MAGI) is between $47,000 and $57,000 ($94,000 and $114,000 if you file a joint return). You cannot claim a credit if your MAGI is $57,000 or more ($114,000 or more if you file a joint return).
Eligible family members include the taxpayer, the taxpayer's spouse, and the taxpayer's dependent(s). To qualify for the credit, the taxpayer must not be claimed as an exemption on another person's tax return or have a tax filing status of married filing separately.
You cannot combine the Hope credit with other education tax benefits (such as the lifetime learning credit or tuition and fees deduction) in the same year for the same child.
You cannot claim a Hope credit on expenses covered by any Employer-Provided Tuition Assistance program.

For more information, see IRS Publication 970, chapter 2, "Hope credit."

Lifetime learning credit

Eligible taxpayers can receive a credit up to $2,000 annually: 20% of the first $10,000 paid for qualified education expenses as part of a postsecondary degree program or to acquire or improve job skills. Unlike the Hope credit, there is no limit on the number of years you can claim a lifetime learning credit.

Qualified expenses include tuition and fees required for enrollment in one or more courses at an eligible postsecondary institution.

The amount a taxpayer may claim as a lifetime learning credit is gradually reduced for taxpayers who have modified adjusted gross income between $40,000 ($80,000 for married taxpayers filing jointly) and $50,000 ($100,000 for married taxpayers filing jointly). Taxpayers with modified adjusted gross income over $50,000 ($100,000 for married taxpayers filing jointly) may not claim a lifetime learning credit.

Eligible family members include the taxpayer, the taxpayer's spouse, and the taxpayer's dependents. To qualify for the credit, the taxpayer must not be claimed as an exemption on another person's tax return or have a tax filing status of married filing separately.

You cannot combine the lifetime learning credit with other education tax benefits (such as the Hope credit or tuition and fees deduction) in the same year for the same child.

You cannot claim a lifetime learning credit for expenses covered by any employer-provided tuition assistance program.

For more information, see Notice 97-60 Lifetime Learning Credit.

Tuition and fees deduction

The IRS allows eligible taxpayers to deduct up to $4,000 from their income subject to tax for qualified education expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent. The deduction can be claimed in place of a Hope or lifetime learning credit, especially for taxpayers whose MAGIs are too high to qualify for those credits.

Your maximum tuition and fees deduction is $4,000 if your MAGI is less than $65,000 for filing an individual return or less than $130,000 for filing a joint return.

Your maximum tuition and fees deduction is $2,000 if your individual MAGI is $65,000–$80,000 or your joint MAGI is $130,000–$160,000.

To qualify for the deduction, the taxpayer must not be claimed (or eligible to be claimed) as an exemption on another person's tax return or have a tax filing status of married filing separately.

You cannot combine the tuition and fees deduction with the Hope or lifetime learning credits in the same year for the same student.

For more information, see IRS Publication 970, chapter 6, "Tuition and Fees Deduction."

Student loan interest deduction

According to the IRS, you can deduct up to $2,500 from your income subject to tax for the interest you paid on a federal or private student loan (not loans from a relative or employer) during 2006. The loan must have been received to help pay qualified education expenses — including tuition, fees, room, board, books, supplies, and transportation — at an eligible postsecondary institution.

Student loan interest is not deductible if paid by your participation in the National Health Service Corps Loan Repayment Program or certain other state loan repayment programs.
You can take a student loan interest deduction if someone else makes an interest payment on your behalf, such as an employer or family member.
Available for individuals with MAGIs under $65,000 (lesser deduction if $50,000–$65,000) and married filers with MAGIs up to $135,000 (lesser deduction if $105,000–$135,000).

For more information, see IRS Publication 970, chapter 4, "Student Loan Interest Deduction."

Traditional and Roth IRA withdrawals

Consider these factors when weighing this benefit.

IRA withdrawals before age 59-1/2 are allowed without the 10% early withdrawal penalty if funds are used for qualified education expenses.
Qualified expenses include tuition, fees, books, supplies, equipment, and certain expenses related to special needs students; room and board are included if the student attends school at least half time.
There are no income requirements.
IRA withdrawals may be used for yourself, your spouse, or any child or grandchild of either individual.

For more information, see IRS Publication 970, chapter 9, "Education Exception to Additional Tax on Early IRA Distributions."

Coverdell Education Savings Accounts (ESAs)

The Coverdell ESA is a savings account created or organized in the United States for the sole purpose of paying the qualified education expenses of the designated beneficiary of the account. Qualified taxpayers can contribute up to $2,000 per calendar year into an ESA for each designated beneficiary under age 18. The beneficiary need not be your dependent child. Here are the highlights.

Withdrawals are tax-free and penalty-free, as long as funds are used for qualified education expenses. For higher education, these include tuition, fees, books, supplies, and equipment required for enrollment; expenses for special needs students; and room and board for students attending school at least half time.
Anyone can contribute to an ESA if their MAGI is under $110,000 (contribution amount is reduced for incomes of $95,000–$110,000) and joint filers with MAGIs under $220,000 (contribution amount is reduced for incomes of $190,000–$220,000).
You can claim a Hope credit or lifetime learning credit and qualified tuition program (QTP) or 529 plan withdrawal with a tax-free ESA withdrawal in the same year, as long as the ESA withdrawal does not cover the same expenses claimed for the Hope or lifetime learning credit or QTP (529 plan) withdrawal.

For more information, see IRS Publication 970, chapter 7, "Coverdell Education Savings Account (ESA)."

Qualified Tuition Programs (QTPs), 529 plans

States and educational institutions allow taxpayers to prepay or contribute to a tuition savings account on behalf of a designated beneficiary.

Start one today at www.Upromise.com.

Employer-provided tuition assistance

According to the IRS:

Taxpayers can exclude from their income up to $5,250 of employer-provided tuition assistance for undergraduate or graduate-related course work.
You cannot claim a Hope or lifetime learning credit for expenses covered by tuition assistance from your employer.

Check with your employer's human resources department or IRS Publication 970, chapter 11, "Employer-Provided Educational Assistance" for details.

Education savings bond program

You may be able to cash in qualified U.S. savings bonds to pay tuition and fees at an eligible educational institution without having to include in your income some or all of the interest earned.

For 2007, the amount of your interest exclusion is phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your MAGI is between $98,400 and $128,400. You cannot exclude any of the interest if your MAGI is $128,400 or more. (For 2006, the limits that applied to you were $94,700 and $124,700.) For all other filing statuses, your interest exclusion is phased out if your MAGI is between $65,600 and $80,600. You cannot exclude any of the interest if your MAGI is $80,600 or more.
Eligible family members include the taxpayer, the taxpayer's spouse, and the taxpayer's dependent(s). To qualify for the credit, the taxpayer must not be claimed as an exemption on another person's tax return or have a tax filing status of married filing separately.

Qualified U.S. savings bonds must meet the following requirements:

series EE bond issued after 1989,
series I bond,
bond must be issued in your name (as the sole owner) or in the name of both you and your spouse (as co-owners), and
the owner must be at least 24 years old before the bond's issue date (printed on the front of the savings bond).

Visit IRS Publication 970, chapter 10, "Education Savings Bond Program" for details.

Tax and savings benefits

Your financial success