The Tax Credit on Contributions to a College Fund

ESAs offer tax advantages, but not tax credits for contributions.

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The federal tax code offers incentives to help you pay for college for yourself and your dependents. Certain deductions reduce your taxable income, tax credits result in a lower income tax bill and exclusions are not included in your income for purposes of determining your tax. Qualified savings plans are another option, although contributions do not qualify for a deduction, credit or exclusion, the interest your deposits earn accumulates tax-free until you begin withdrawing money. If the amount withdrawn is less than or equal to actual qualified expenses, the funds are not taxable. A better understanding of contributions to a college fund and the tax implications can be had by examining the different types of tax benefits available.

Tax Credits

As of 2012, the Internal Revenue Service supports two types of tax credits for education, the American Opportunity Credit and the Lifetime Learning Credit. Both credits are for post-secondary education, and both credits require you to actually pay a qualified educational expense before you can claim the credit. By contrast, college accounts may be funded many years before the first penny is spent. The American Opportunity Credit is limited to $2,500 per year per student. Income limits also apply. If you are single, your modified adjusted gross income cannot exceed $80,000, and it cannot exceed $160,000 for married couples filing joint returns. The Lifetime Learning Credit is not subject to income limits, but the maximum credit is $2,000 per year.

Savings Accounts

Savings accounts allow students or their parents to accumulate funds prior to enrolling in college. The Coverdell Education Savings Account can be used to pay for any level of education from kindergarten through graduate school. The student or beneficiary can use the funds to pay qualified educational expenses without having to pay taxes on the interest or dividends earned by the account. Beneficiaries must be under 18 years of age or qualify as having special needs at the time the contributions are made. Regardless of how many accounts are established for the individual, total contributions cannot exceed $2,000 per year and are not tax-deductible. State-sponsored 529 plans allow parents or students to contribute to a savings account for post-secondary education. Some universities also permit prepayment of expenses under the same IRS code. Contributions are not subject to income limits, nor is there a maximum amount that can be contributed. Like a Coverdell plan, the only tax advantage is that earnings are not taxable if used to pay qualified educational expenses.


You can reduce your taxable income by as much as $4,000 if you qualify for a tuition and fees deduction. The deduction is restricted to those with a modified gross income of $80,000 or less, if single, or $160,000 or less, if married. Married couples cannot file separate returns and claim the deduction. The student must be shown as a dependent on the return; no other taxpayer can be eligible to claim the student as a dependent. If you are making payments on a student loan, you may be able to deduct the interest paid. The maximum deduction is $2,500 per year, and your modified adjusted gross income cannot exceed $75,000 if single or $150,000 if married and filing jointly. If you work for yourself or others, you may be able to deduct educational expenses you incur for educational costs directly related to your job. To claim the deduction, you must itemize, if you are self-employed, or complete Schedule F, Schedule C or Schedule C-EZ if you are self-employed.


Certain educational benefits are excluded from your taxable income. For example, a scholarship issued to pay the tuition at an accredited university may be tax-exempt. Your employer can pay up to $5,250 per year for your qualified educational expenses without having to include them in your income, although amounts in excess of that limit are taxable income and will appear on your W-2 at year-end. Grants that are based on financial need, such as Pell Grants, are not taxable if used for qualified educational expenses. Educational payments received from the Department of Veterans Affairs are excluded from taxation, as is any housing allowance you receive from the VA.