I'm Stephanie Morris, CPA. It’s time to sharpen pencils, buy books, and head back to the classroom. Let’s go back to school with a lesson on 2021 education tax breaks!
The first question you may be asking yourself is, what is a tax break? A tax break means that the federal government is offering you a tax reduction for a specified reason. The cost of education can be a major expense for families and individuals. Any informed tax professional should be able to equip their clients with the knowledge needed to plan ahead and take advantage of education tax breaks, tax credits, exclusions and other saving incentives. In this article, I’ll walk you through different education tax breaks and how much they may save your clients. Class is in session!
Tax deductions
- No more tuition and fees deduction. The Consolidated Appropriations Act (CAA) of 2021 (H.R. 133) signed into law on December 27, 2020 officially put an end to the tuition and fees deduction after the tax year 2020. This tax deduction was previously an adjustment (“above the line”) for adjusted gross income (AGI) worth up to $4,000.
- Student loan interest. An “above the line” tax deduction for up to $2,500 is available for student loan interest used to pay qualified education expenses. Tuition and fees, required course materials, room and board and other necessary costs of education are all qualified expenses for purposes of the tax deduction. For 2021, the deduction phases out for modified AGI from $70,000 to $80,000 (unmarried) and $140,000 to $170,000 (married filing jointly).
Tax credits
- Improved education credits. The American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit (LLC) are two education credits available to taxpayers. To mitigate the loss of the tuition and fees deduction, the Consolidated Appropriations Act increased the impact of the Lifetime Learning Credit. For expenses that qualify for both the AOTC and the LLC, taxpayers may only claim one of the tax credits. Information for claiming the education credits is provided to taxpayers on Form 1098-T.
- American Opportunity Tax Credit: The AOTC allows a tax credit for up to $2,500 per student for the first four years of education after high school. The calculation of the credit is 100 percent of the first $2,000 of eligible expenses paid by the taxpayer plus 25 percent of the next $2,000 of eligible expenses. Eligible expenses for the credit include tuition and fees, books, and required course materials. Students must be enrolled at least half time. Room and board are not eligible expenses for the credit. Forty percent of the AOTC is refundable, and the credit is phased out from $80,000 to $90,000 AGI (unmarried) and $160,000 to $180,000 (married filing jointly).
- Lifetime Learning Credit: The LLC allows a tax credit for up to $2,000 per tax return with no limit on the number of years a taxpayer may claim the tax credit. As the name suggests, the LLC is meant to reward lifetime learning. The credit can pay for undergraduate, graduate, and professional degree courses, including courses to acquire or improve job skills. The calculation of the credit is 20 percent of a maximum of $10,000 eligible expenses, which include tuition and fees, but not course materials. Room and board are also not eligible expenses, and the LLC is not a refundable credit. The CAA of 2021 permanently increased phase-out thresholds to match those of the AOTC.
Tax exclusions
- The first tax exclusion is scholarship income. Amounts received from scholarships and used to pay for tuition, fees, and required course-related materials can be excluded from income by college students. The scholarship must not represent payment for services. Undergraduate and graduate scholarships are eligible, and there are no income phaseouts for the exclusion. Revenue Ruling 77-263 addresses athletic scholarships and states that the amount received for athletic scholarships is excludable from gross income if the university “expects” but “does not require” the student to participate in a sport, requires no activity in lieu of participation, and is not canceled if the student cannot participate in the sport.
- Another tax exclusion is employer-provided educational assistance. Employees may exclude up to $5,250 of employer-provided educational assistance used for tuition and fees, course-required materials, and even student loan payments for undergraduate and graduate education. Principal and interest payments paid by an employer after March 27, 2020 and before January 1, 2026 are eligible for the exclusion.
- The third tax exclusion is forgiven student loan debt. Taxpayers, regardless of solvency, are allowed to exclude from income any student loan debt forgiven from 2021 to 2025. The student loan proceeds must have been used to pay for tuition and fees, required course-related materials, room and board, and any other necessary educational expenses (including transportation).
- The final tax exclusion is interest on education savings bonds. The interest on qualified education savings bonds can be excluded from income when proceeds of the education bond redemption are used to pay eligible education expenses. Qualified education expenses for the purpose of the education savings bond interest exclusion include tuition and fees and contributions to a qualified tuition program. The exclusion benefit is phased out in 2021 for modified AGI of $82,350 to $97,350 (unmarried) and $122,550 to $153,550 (married).
Savings incentives
- Qualified Tuition Programs (529 Plans). Earnings on investments in 529 plans may be excluded from income if used to pay for qualifying education expenses. Eligible expenses include tuition and fees, required course materials, and room and board (if student is enrolled at least half time) for undergraduate and graduate education. In addition, up to $10,000 per beneficiary per year may be used to pay K-12 tuition expenses. A lifetime limit of $10,000 per borrower may be used to repay student loan principal and interest. Annual contribution limits are set by individual states. There are no AGI limitations.
- Coverdell Education Savings Account. A $2,000 contribution per beneficiary per year is allowed under the Coverdell Education Savings Account. Earnings on investments are not taxed if used for K-12 or higher education eligible expenses. Allowed contributions are phased out for taxpayers with AGI of $95,000 to $110,000 (unmarried) and $190,000 to $220,000 (married).
All tax preparers should fully understand the different types of education tax breaks to best serve clients with special educational tax break considerations.
Keep reading the Becker blog for more important tax updates that all tax professionals, accountants and CPAs should be in-the-know of.
The education tax break content contained in this article is for informational purposes only and is not tax advice. You should consult a tax advisor for advice applicable to your situation.
Need a refresher on tax law changes in 2021? Head to Becker’s Tax Resource Center for helpful news and tax resources to prepare yourself for the new tax season.
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