Fortunately, in recent years, our government has been making efforts to add tax benefits for families with children in college. Some of these are better than others, but all of them require you to keep track of your education expenses and to compare them to your IRS form 1098-T.
Most families will qualify for some income tax relief as a result of paying for college expenses. As of this writing there are three types of tax credits that you may qualify for. The Hope, Lifetime Learning and American Opportunity credits all provide a direct income tax reduction of up to $2,500 per year, per student in college. But you can only use one of these credit programs per college student, per income tax year.
Tax Credits: These are the best form of income tax savings as they can actually increase your tax refund, (by reducing your taxes) dollar for dollar, in the exact amount of the credit that you qualify for. If you have two children in college, you could reduce your income taxes by up to $5,000 each year, just from these tax credits alone.
Student Loan Interest: There is also an income tax deduction for student loan interest which can be used to reduce your taxable income by the amount of student loan interest that you paid during the year. This isn't quite as good as a direct credit, because it only reduces your taxable income. As an example is you are in a 28 percent tax bracket and you have a $1,000 deduction for student loan interest, it will save you $280. (eg. $1,000 x.28 = $280)
Tuition and Fees Deduction: If you are unable to qualify for the tax credits, you may qualify for the Tuition and Fees income tax deduction which allows you to reduce your taxable income for an amount up to the amount you pay for tuition and certain approved college fees. There is a cap on this and it can vary depending on the number of students in college and your income. Like the student loan interest deduction above, the savings are based on your tax bracket.
Education Savings Deductions: There are also tax breaks for using Coverdell Education Savings Accounts (CESA), and IRS Section 529 college savings plans. These are also deductions from your taxable income in an amount up to the amount you contribute to these education savings plans. There are limits on these deductions and the contributions; but these limits can vary by state, so check with yours.
Employer Programs: Another income tax savings program may exist in the form of employer-provided educational assistance programs. These allow you to receive help, usually in the form of a reimbursement, from your employer to cover some or all of the costs associated with your college education. Your employer gets the deduction for these expenses, but you receive the reimbursement money tax-free in most cases.
Work Related Education: Lastly, you may qualify for a deduction for work-related education expenses, if your education costs were not reimbursed and you meet certain IRS criteria. To be able to deduct these expenses, you have to itemize your deductions on Schedule A and must have enough miscellaneous expenses to exceed two percent of your adjusted gross income.