The federal government rewards those seeking higher education and job training with some very nice tax laws. These can be confusing, so I will try to help you make sense of these so that you may be better prepared at your tax appointment. First of all let us see what is available.
The American Opportunity (Hope Credit extended) and the Lifetime Learning Credit are education credits you can subtract in full from the federal income tax, not just deduct from taxable income. The Tuition and Fees Deduction will reduce your taxable income.
The American Opportunity Tax Credit is designed to reduce the costs of the first four post-secondary education years. It allows a maximum annual credit of $2,500 per student and includes all required course materials as well as tuition and fees of qualifying expenses at any institute of higher learning that is eligible to participate in the federal student loan program.
The full credit is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above these levels. These income limits are higher than under the existing Hope and Lifetime Learning Credits.
The Lifetime Learning Credit is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses--including courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return.
The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000. This deduction is taken as an adjustment to income. This means you can claim this deduction even if you do not itemize deductions on Schedule A (Form 1040). This deduction may be beneficial to you if you do not qualify for the American opportunity or Lifetime Learning Credits.
Which schools qualify?
An eligible educational institution is a school offering higher education beyond high school. It is any college, university, vocational school, or other post secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education.
Education costs must be paid with "after-tax money" this includes student loan proceeds:
You cannot claim a deduction or credit based on expenses paid with tax-free scholarships, fellowships, grants, or education savings account funds such as a Coverdell education savings account, tax-free savings bond interest or employer-provided education assistance. The same rule applies to expenses you pay with a tax-exempt distribution from a qualified tuition plan, except that you can deduct qualified expenses you pay only with that part of the distribution that is a return of your contribution to the plan.