Tax deductions for students

Elizabeth Rosen
by Elizabeth Rosen, Contributor

 

Tax deductions lower your taxable income and they are equal to the percentage of your marginal tax bracket. For instance, if you are in the 25% tax bracket, a $1,000 deduction saves you $250 in tax (0.25 x $1,000 = $250). There are three main types of tax deductions: the standard deduction, itemized deductions, and above-the-line deductions.

The standard deduction

The standard deduction is a dollar amount that reduces your taxable income. It is usually adjusted for inflation every year. Your standard deduction amount is based on your filing status, and it is subtracted from your AGI (adjusted gross income). A taxpayer must use one or the other, but not both. It is generally recommended that you itemize deductions if their total is greater than the standard deduction. The standard deductin for 2010 is as follows (based on your filing status):

  • $5,700 for single filers
  • $5,700 for married taxpayers filing separately
  • $11,400 for married joint filers
  • $8,400 for head of household filers

The standard deduction for 2011 is as follows (based on your filing status): The standard deduction can be claimed on IRS Tax Form 1040, IRS Tax Form 1040A, or IRS Tax Form 1040EZ. The standard deduction amount can change from year to year, and is based mainly on inflation. The amount of your standard deduction can be reduced if you are claimed as a dependant on another person’s return. In most cases, the amount of the deduction is the greater of your earned income for the year plus $300 or $950. There are several groups of people who do not qualify for the standard deduction. They include: a married individual with “married filing separately” status and a spouse who is itemizing deductions, a person who is classified as a “nonresident alien,” and a person who has changed his accounting cycle and is not filing for a full 12-month period. Understanding the standard tax deduction is very important. This makes it easier for you to decide whether taking the standard deduction or itemizing your deductions is the best route for you.

Itemized deductions

If you do not qualify for the standard deduction, you may choose to itemize your tax deductions. A taxpayer will also typically itemize deductions if it offers them more benefits than the standard deduction (i.e., when the total amount of qualified deductible expenses is greater than the standard deduction). Certain itemized deductions are based on a minimum (or “floor”) amount. This means that you can only deduct amounts that exceed the specified “floor.” There is also an income limit for taxpayers who itemize. If your AGI (adjusted gross income) exceeds $166,800 then a portion of itemized deductions is not permitted ― this income limit applies to single and married filers. If you decide to itemize your tax deductions, it is important to keep detailed records of those tax deductions ― including documentation for medical expenses, property taxes, charitable donations, interest expenses, and nonbusiness state income taxes. The sum of your tax deductions, if itemized, is subtracted from your gross income. The number that is left is known as your adjusted gross income (AGI). Common tax deductions include: student loan interest, mortgage interest, traditional IRA contributions, tuition payments, and alimony payments. Of course, this is just a small sampling of the many deductions that may be available to you. You may use IRS Tax Form 1040 Schedule A to figure your itemized deductions, and attach it to your IRS Tax Form 1040 (but not Form 1040A or Form 1040EZ).

Above the line deductions

Above-the-line tax deductions are taken before your AGI is calculated (instead of after, like the other deductions). Because of this, many believe this type of tax deduction to be more advantageous to taxpayers. Above-the-line deductions are subtracted from your gross income, and the resulting number is your AGI. These tax deductions apply whether you itemize or not. They are designed to help protect your personal exemptions and itemized deductions from phaseouts. Some above-the-line deductions include the following:

  • Student loan interest
  • Business mileage
  • Moving expenses
  • Alimony
  • Contributions to qualified retirement accounts
  • Early withdrawal penalties

Tax deductions for educational expenses

Tax deduction for student loan interest

The Student Loan Interest Deduction is an education tax benefit that allows taxpayers to deduct up to $2,500 of the interest paid on student loans. This education tax deduction can be claimed on your federal income tax return to reduce your taxable income. Student loan interest is the interest that you paid during the year on a qualified education loan. You can deduct all the interest you paid on your student loan during the year, which includes voluntary interest payments. This deduction is claimed as an adjustment to your income. That means you do not need to itemize your deductions (on Schedule A Form 1040) in order to claim the student loan interest deduction. A qualified student loan, or education loan, is defined as follows:

  • A loan that you took out solely to pay for qualified higher education expenses
  • A loan that is used for an eligible student (you, your spouse, or your     dependent) who is enrolled in a degree program at least half-time
  • A loan that is not from a relative or qualified employer plan

You may claim the student loan interest deduction if you meet all of the following requirements:

  • You paid interest on a qualified student loan in tax year 2011
  • You are legally obligated to pay interest on a qualified student loan
  • Your filing status is not married filing separately
  • Your modified adjusted gross income is less than a specified amount which is set annually
  • You and your spouse, if filing jointly, cannot be claimed as dependents on someone else's return

The amount of your education tax deduction is based on your income level. The maximum amount you can claim for the student loan interest deduction in 2011 is $2,500. If you paid $600 or more in interest on a qualified student loan during 2011, you will receive a Form 1098-E (Student Loan Interest Statement) from the entity to which you paid the student loan interest. The following items cannot be claimed for a student loan interest tax deduction:

  • Interest that you paid on a loan if you were not legally obligated to make interest payments under the loan terms
  • Fees for lender services, such as loan origination fees and processing costs
  • Interest payments that you made through a loan repayment assistance program (such as the National Health Service Corps Loan Repayment Program, NHSC)

To claim the student loan interest deduction, you must include it as an adjustment to your income. (Remember, you do not have to itemize your deductions for this education tax benefit.) The tax deduction can be claimed by entering the allowable amount of your deduction on Line 33 of IRS Tax Form 1040 (or Line 18 of Form 1040A; or Line 32 of Form 1040NR; or Line 9 of Form 1040NR-EZ).

Tax deduction for tuition and fees

The “Tuition and Fees Deduction” is an education tax benefit that allows taxpayers a tax deduction if they paid the qualified education expenses for an eligible student (themselves, their spouse, or a dependent). It is an above-the-line deduction that may reduce your taxable income by up to $4,000. You may claim the Tuition and Fees Tax Deduction if you meet all of the following requirements:

  • You pay the qualified education expenses of higher education
  • You pay the education expenses for an eligible student
  • The eligible student is yourself, your spouse, or a dependent for whom you claim an exemption on your tax return

You cannot claim the Tuition and Fees Tax Deduction if any of the following applies:

  • Your tax filing status is “married filing separately”
  • Another person can claim you as a dependent in the Exemptions section of his/her tax return (note that you cannot take this deduction even if the other person does not actually claim you as their dependent)
  • Your modified adjusted gross income (MAGI) exceeds $80,000 (or $160,000 if filing a joint tax return)
  • You (or your spouse) were a nonresident alien for any part of the tax year and did not elect to be treated as a resident alien for tax purposes
  • You (or anyone else) claims the American Opportunity Tax Credit, the Hope Scholarship Tax Credit, or the Lifetime Learning Tax Credit for qualified education expenses for the same student in the same year

Qualified educational expenses include the following:

  • Tuition and related expenses required for enrollment at an eligible educational institution
  • Student-activity fees and course-related books, supplies, and equipment that are paid as a condition of attendance

Expenses that do not qualify for a Tuition and Fees Deduction include the following:

  • Insurance
  • Medical expenses (including student health fees)
  • Room and board
  • Transportation
  • Similar personal, living, or family expenses

An eligible student is one who is enrolled at a qualified educational institution, who has either a high school diploma or GED (General Educational Development) credential. With the Tuition and Fees Deduction, you can reduce your taxable income by up to $4,000. However, note that there is a limit for claiming this tax deduction, based on your MAGI (modified adjusted gross income). Those limits are $160,000 for married joint filers, and $80,000 for those filing as single, head of household, or qualifying widow(er). The Tuition and Fees Deduction is claimed as an adjustment to income on Form 1040 or Form 1040A. To claim this deduction, you must complete IRS Tax Form 8917 (Tuition and Fees Deduction) and submit that with your Form 1040 or Form 1040A.

Rules for combining education tax benefits

Note that there are specific rules regarding which education tax benefits may be used in the same tax year. Federal education tax deductions include the Tuition and Fees Deduction and the Student Loan Interest Deduction. Federal education tax credits include the American Opportunity Tax Credit, the Lifetime Learning Tax Credit, and the Hope Scholarship Tax Credit. You cannot use the Tuition and Fees Deduction if you claimed a tax credit (American Opportunity, Lifetime Learning, or Hope) for education expenses for the same student in the same year. However, the Tuition and Fees Deduction can be used in conjunction with some other education tax benefits, including tax-free distributions from Coverdell ESAs (Education Savings Accounts), qualified tuition programs, and education savings bonds. To take advantage of these education tax benefits simultaneously, different education expenses must form the basis for each separate benefit. For more information about these types of tax deductions, please see IRS Publication 970 (Tax Benefits for Education).