Federal Tax Deduction for Education Credits
The Internal Revenue Service (IRS) offers tax credits to individuals seeking to increase their knowledge through continuing education or degree programs. This includes single courses, degree programs and certification programs. Different classes and educational institutions may limit some education tax credits; consult your tax adviser on your specific situation. You deduct your education tax credit on your personal tax return against tax owed.
The Facts
Tax deductions benefit you through reducing taxable income. Your tax is determined by subjecting your taxable income to each respective tax bracket up to your total income. For example, if you are single in 2008 with taxable income of $50,000, your tax rate on the first $8,025 is 10 percent. The tax rate on taxable income from $8,025 to $32,550 is 15 percent. Your taxable income from $32,550 to your total taxable income of $50,000 is subject to a 25 percent tax rate. A $2,000 tax deduction in the above example, with $50,000 in taxable income may only reduce your tax owed by $500, because your highest tax rate was 25 percent. Conversely, tax credits provide the best taxable benefit. You are able to deduct a tax credit directly against tax owed rather than taxable income. If your tax for any given year is $5,000 and you are eligible to claim a $2,000 tax credit, your tax owed is $3,000.
Types
Two federal education tax credits exist. The hope credit is available for your first two years of a U.S. Department of Education accredited college degree or program. Your enrollment must be at least half-time during one semester in the year tax year. Taxpayers with felony drug charges cannot claim the credit. The lifetime learning credit pertains to all courses for job skill improvement and degree fulfillment. Individual states may have programs available for educational tax credits as well. Check your state revenue website for more information.
Considerations
Your credit is determined from your income and your qualified expenses, which include tuition and other expenses required as a condition of enrollment. Expenses required as a condition of enrollment may include books, supplies and activity fees. The IRS imposes an income dollar limit where the credit begins to phase-out, until it is completely unusable. The phase-out limits are subject to change each year. Tuition and other qualified expenses are deductible in the year you incur the expenses, even if you paid with loan proceeds. Reimbursement, gifts and scholarships reduce your qualified tuition for the purposes of determining your education credit.
Warning
You could be required to recapture either of the educational tax credits if you receive reimbursements for tuition paid. Recapture requires you to claim the previously reported credit as income and it becomes taxable. Never deduct both credits in the same year as the IRS allows you deduct one credit in a given year. If eligible for both credits, you should calculate and determine what credit will work better for you by using IRS form 8863. Also, be aware that the Hope credit is limited to your first year years of your degree or program.
Expert Insight
Each credit is determined differently. Using the credit that awards you the largest benefit produces the best deduction against taxes owed on your personal tax return. The IRS allows a 100 percent deduction for the first allowable portion and a 50 percent deduction for the second allowable deduction. The IRS allows a 20 percent deduction of total qualified education expenses with a ceiling that is subject to change each year. The allowable deduction limits are subject to change annually. Consult IRS rules for your current tax year to determine your credit.
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