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Should I use the Lifetime Learning Credit or an education deduction?

 

Should I use the Lifetime Learning Credit or an education deduction?

Brandon Lafving
by Brandon Lafving, IRS contributor (@TechDragoon)

If you already have a college degree and want to continue your education, then you have a choice when it comes to the form of your education tax break. You can either go for the Lifetime Learning Tax Credit, or take a deduction. The math problem is: when is it better for you to take the deduction?

Generally speaking, the Lifetime Learning Tax Credit is a more powerful tax break. First, it is a credit, meaning that the money you receive is subtracted from your total tax obligation.

READ: Will I be be taxed for employer tuition assistance?

So if you receive a $2,000 credit, your taxes are reduced by $2,000. That is stronger than a deduction, which reduces your taxable income. The total possible education deduction is $4,000. Your actual savings from taking the full deduction would be:

$4,000 x Effective Tax Rate=Tax Break

Let's say you are in the 25% tax bracket, and you pay self-employment tax, which is 13.3%.

Then your effective tax rate is roughly 38.3%. Your tax break would be:

$4,000 x .383=$1,532

Which means you would want the Lifetime Learning Credit, right? Not always, and here's the catch.

There are actually 2 catches. The first involves the amount of money you spent on education. The Lifetime Learning Credit only credits 20% of the amount you spend up to $10,000. So if you only spent $4,000 on tuition and related, necessary costs, you would want to take the deduction instead. Seeing how expensive education is these days, I will continue as though you paid more than $10,000.

READ: Tax-savvy ways to save for your child's college expenses

The second catch depends on your income. The Lifetime Learning Tax Credit is capped at a modified adjusted gross income (MAGI) of $62,000 ($124,000 if married filing jointly). There is also a phase-out for MAGIs over $52,000 ($104,000 jointly). For every $1,000 ($2,000 jointly) you take home above the phase-out threshold, you lose 10% of the credit. This amounts to $200 for every $1,000 your MAGI is above the threshold.

Here is a table that shows the relationship clearly.

MAGI (jointly)

Credit

$53,000 ($106,000)

$1,800

$54,000 ($108,000)

$1,600

$55,000 ($110,000)

$1,400

$56,000 ($112,000)

$1,200

 

And so on. As you can see, to optimize your tax savings, you would probably want to take the deduction once your MAGI crosses above $55,000 ($110,000). After $65,000, your maximum deduction is reduced. And you cannot take a deduction after you reach $80,000.

Self-employed professionals mark down their education deduction on Form 1040, Schedule C. As an employee, you can either itemize, or fill out Form 8917, Tuition and Fees Deduction. The Lifetime Learning Credit requires Form 8863.