The Internal Revenue Service offers three different tax breaks for higher education costs: the American opportunity credit, the lifetime learning credit and the tuition and fees deduction. However, you're allowed to claim only one tax benefit for education per year, so picking the one that gives you the most money back -- as long as you're eligible -- can make a big difference on your tax return.
Federal Tax Savings
For most people, either the American opportunity credit or the lifetime learning credit will offer greater income tax savings. The American opportunity credit offers a maximum credit of $2,500, which requires only $4,000 of qualified expenses. The lifetime learning credit offers a credit of 20 percent of up to $10,000 in expenses, for a maximum credit of $2,000. The tuition and fees deduction allows you to deduct $4,000. Since it's a deduction, you have to multiply the deduction by your tax rate to figure the savings. For example, if you fall in the 30 percent tax bracket, a $4,000 deduction saves you $1,200.
The qualified expenses for all three tax breaks include tuition and fees required for attendance.However, for the American opportunity credit, you can also include the costs of books and supplies, even if you do not purchase them through the school. In addition, to qualify for the American opportunity credit, you must be in your first four years of post-secondary education. If you've already completed your bachelor's degree, you cannot claim the American opportunity credit.
Only students who do not have any felony drug convictions on their record are eligible to claim the American opportunity credit. Neither the lifetime learning credit nor the tuition and fees deduction have such a requirement. In addition, all three tax benefits have income limitations. The American opportunity credit has the highest income limits, followed by the tuition and fees deduction. The lifetime learning credit has the lowest income limits.
The tuition and fees deduction is an adjustment to income, which means that it reduces your federal adjusted gross income. More than 40 states use the federal adjusted gross income as a starting point for calculating state income taxes. As a result, claiming the tuition and fees deduction will often reduce your state income tax as well as your federal income tax. Tax credits, on the other hand, will not.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."