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Tax breaks for college expenses

Here's a scary statistic: The average cost of a private, four year college is $26,273, an increase of 4.4% from last year. That works out to more than $100,000 per degree. As the mother of three kids (and a former student still paying off grad school loans), those numbers are pretty intimidating.

Fortunately, there are some tax breaks meant to make the cost of going to college more affordable -- and not just for kids. Here are some deductions and credits that are currently available:

  • Hope Credit. You may be eligible to claim the Hope Credit for yourself or your dependents who are college students. The credit, which was signed into law as part of the Taxpayer Relief Act of 1997, was intended to benefit students in their first two years of college. The maximum amount of the Hope Credit is $1,800 (or $3,600 if a student is in a Midwestern disaster area) and is available only for two tax years per eligible student. To qualify, a student must be pursuing a degree and enrolled at least half time for at least one semester beginning during the tax year. The credit is available for tuition and required enrollment fees and is not refundable. Here's the catch: At least one student on your return must meet the additional requirement of having attended an eligible educational institution in a Midwestern disaster area in 2009 -- you must claim the Hope credit for that student in order to claim the Hope credit for any other qualified student.
  • American Opportunity Tax Credit. There's a reason for the limitations imposed on the Hope Credit: As part of the American Recovery and Reinvestment Act, the Hope Credit has been modified for 2009 and 2010. The new version of the credit is now referred to as the American Opportunity Tax Credit and is worth up to $2,500 -- a $700 increase over the existing Hope Credit. The credit is available for 100% of the first $2,000 of tuition, fees, and course materials paid during the taxable year, plus 25% of the next $2,000 of tuition, fees and course materials. In addition, the credit can be claimed for expenses for the first four years of post-secondary education so long as the student is pursuing a degree and is enrolled at least half time during the semester. The credit is available if you pay qualified education expenses of higher education for yourself, your spouse or a dependent for whom you claim an exemption on your tax return. For purposes of the credit, "qualified education expenses" now includes books as well as tuition, related fees and other required course materials. Up to 40% of the American Opportunity Credit is refundable, which means that even if you owe no tax, you can get some money back.
  • Lifetime Learning Credit. You may be eligible for a tax credit of up to $2,000 ($4,000 for students in Midwestern disaster areas) on the first $10,000 of college tuition and fees for yourself or your dependents, provided you are responsible for paying those expenses. This credit is available for students who take at least one course, and there is no requirement that you pursue a degree. There is also no limit on the number of years the Lifetime Learning Credit can be claimed. The title pretty much says it all: It's a credit against tuition and expense paid no matter what you're studying, no matter how long. It just needs to be a course at an eligible educational institution to acquire or improve job skills. An eligible educational institution is virtually any college, university, vocational school, or other post-secondary educational institution that participates in a student aid program administered by the U.S. Department of Education -- just ask the school to find out whether it's an eligible institution.
When evaluating these credits, remember that you have to choose: You cannot claim a Lifetime Learning Credit and a Hope Credit or an American Opportunity Credit based on the same qualified education expenses. Additionally, you cannot claim a Lifetime Learning Credit in the same year that you are claiming a tuition and fees deduction for the same student.

Most of the education-related tax credits are subject to income limitations. You generally cannot claim an educational credit if your filing status is married filing separately; you can be claimed as a dependent by another person; or if you or your spouse were a nonresident alien for any part of 2009 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. For more information about the restrictions on specific credits, refer to IRS Publication 970.

In addition to, or as an alternative to, tax credits, you may qualify for tax deductions:

Tuition and Fees Deduction. Expenses for tuition, registration fees, and other fees for yourself and your dependents who attend eligible educational institution (see Lifetime Learning Credit, above) may qualify for the Tuition and Fees Deduction. The deduction is limited to $4,000 per year and is taken as an adjustment to income -- sometimes called an "above the line" deduction. This means you can claim this deduction even if you don't itemize. Even taken above the line, deductions are generally less advantageous than a tax credit. However, that's not always the case -- you should run the numbers to see which gives you the most benefit.

Student Loan Interest. Student loan interest is generally deductible on your tax return as an "above the line" deduction, just like the Tuition and Fees Deduction. Again, this means you don't have to itemize in order to claim the deduction -- up to $2,500. To qualify, you have to be obligated to make the loan payments and you cannot be claimed as a dependent on any other's person's return. Here's the really good part: The IRS allows you to take the deduction even if your parents made the payments during the year, so long as your parents are not obligated to make the payments. In other words, if your parents are feeling generous and want to pay your loan for you, you can claim the deduction if you otherwise qualify.

Income limits apply for most tax deductions and credits, so read the fine print. This list isn't meant to be exhaustive; there may be other tax credits and education-related deductions available to you, depending on your individual circumstances. See IRS Publication 970 for more details and restrictions.

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