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Which is Better, the Tuition Deduction or an Education Credit?

When it comes to getting some of your college expenses back in your pocket, there are basically two options at income tax time: claim one of the two education credits, or the tuition and fees deduction. The question is, which is best for you?

Not How Much, But Where

The key to finding the best option for your taxes is to know how each one of those options works.

Let’s look at the two credits first. No matter which of the two education credits you qualify for – the American Opportunity Tax Credit or the Lifetime Learning Tax Credit – they both operate from the same principle. Tax credits reduce your tax bill by the actual amount of the credit. In other words, once our software figures your total income tax for the year, one of these credits is taken right off the top, cutting your tax bill dollar-for-dollar.

The tuition and fees deduction, on the other hand, is subtracted from your taxable income. Your tax will be lower, but not dollar-for-dollar like a credit. Bottom line, it's generally better to use a tax credit than a deduction, but do your math to get your personal bottom line. Your mileage may vary.

How the Education Tax Breaks Measure Up

When it comes to sizing up the three education tax breaks, reading the fine print pays off. Just going for the option with the biggest number mentioned may not give the best results for you.

The tuition and fees deduction sounds good on the surface; it offers a deduction of up to $4,000. This option is open even if you don’t itemize deductions. But since the deduction is for the taxpayer, not the student, it may not be the most beneficial for those with more than one student in the family.

The American Opportunity Credit is good for four years of undergraduate higher education, and it will pay up to $2,500 for qualifying expenses for each qualifying student. So, a family with two college students could get $5,000 trimmed off its final tax bill – and that’s where the difference with the tuition and fees deduction becomes apparent.

Let’s say a married couple with a taxable income of $75,000 has two college students who qualify under both the American Opportunity Credit and the tuition and fees deduction. Without either, they would have a $6,191 tax bill.

The $4,000 tuition and fees deduction would reduce the taxpayers’ taxable income to $46,000 and leave them still owing $5,591 — a net savings of just $600.

But the American Opportunity Tax Credit is subtracted directly from that $6,191 tax bill, leaving the family with just $1,191 to pay in taxes. That's a whopping net savings of $5,000 for our example family.

The Lifetime Learning Credit is figured a little differently. This credit is equal to 20 percent of the first $10,000 of qualified education expense. The credit is limited to a maximum of $2,000 per year per taxpayer return, not per student. Using our example family, even though there are two qualifying students, the total credit is still just $2,000. In our example, the American Opportunity Credit still comes out on top.

But the Lifetime Learning Credit and the tuition and fees deduction have their place. The Lifetime Learning credit works for those in post-graduate classes, or for taxpayers who take courses to stay current or to advance in their jobs. And the tuition and fees deduction might be more useful if your income is higher than the income limits of the two education credits.

Making Your Choice at Tax Time

When you’re doing your taxes with 1040.com, you can apply for either education credit or the tuition and fees deduction on our Form 1098-T and Education Expenses screen. Our tax return interview will help you fill out the right screens.

Also see: Tax Breaks for Students and New Grads


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