Tax Reform - Impact on Education Credits & Deductions
The recent tax reform made some changes to the tax benefits available for people saving money for college along with those paying down student loans. But, most of the education tax benefits (such as deducting interest on student loans) remain the same.
This article will help explain what has changed starting in 2018.
Current College Students
The American Opportunity Credit - No Change.
The American Opportunity Credit, or AOC, was not affected by the tax reform bill. This credit is as much as $2,500 per student, with up to one thousand dollars of that being refundable. This credit is available for up to four tax years for each student. Students must not have completed their first four years of education (postsecondary) prior to the completion of the relevant tax year. They are required to be enrolled a minimum of half time during an academic period, as well as be studying for a credential or a degree.
This credit is usually claimed by parents. Students and parents will need to communicate about eligible expenses and ensure the paperwork is made available - transcripts, receipts, and Form 1098-T. This credit does not normally benefit graduate students and part-time students.
The Lifetime Learning Credit - No Change
This credit consists of as much as $2,000 for education expenses. Taxpayers can claim this credit in as many tax years as it applies, and there is not a minimum enrollment hours requirement.
This credit is usually beneficial to graduate students, undergrads who are enrolled under half time, or students taking an occasional class for skill development or to complete a degree. This credit is less than the American Opportunity Credit, so if a taxpayer qualifies for both, it is usually best to choose the American Opportunity Credit.
Here is the caveat: parents were able to claim expenses for dependent children under the condition that children do not take personal exemption. Under the Tax Reform, there will be no personal exemptions for anybody - neither the parents, nor the children. Children will take standard deduction doubled from the current amount.
The question that remains open: under this setup, will parents be still allowed to take a credit for higher education of children once the entire concept of the dependent child is eliminated? We will find that out only at the beginning of 2018 filing season.
Grants and Scholarships - No Change
Scholarships remain non-taxable when they are used for qualified tuition expenses and related fees:
Tuition and any fees required for enrollment at eligible educational institutions
- Course expenses (e.g., books, fees, equipment, and supplies) which are required to be paid by all students
Non-qualified expenses include:
- Room & board
- Clerical help
- Other expenses not required by the school
Benefits received as part of a tuition reduction plan are also non-taxable. These plans are usually offered to employees of the school and/or their dependents. Another example are tuition reductions given to graduate students in return for teaching and/or research assistance.
In most other cases, grants and scholarships are taxable.
The law does prevent taxpayers from claiming benefits for the same expense under more than one credit. Taxpayers should consider all possible combinations, such as treating non-taxable scholarships as taxable so they can claim the AOC, when doing their taxes.
Deductions for Tuition and Fees - Eliminated
This deduction was already set to expire, and the tax reform bill did not include measures to extend it. It had allowed as much as $4,000 to be deducted from taxable income. Elimination of this deduction will not affect much students and college graduates.
Most millennials are paying a low marginal rate and aren’t likely benefiting much from the deduction anyway. They will gain much more from the doubling of the standard deduction under the tax reform plan than they will lose from the disappearance of this deduction..
Waiver of Penalties for Early IRA Distribution - No Change
There was no change to this benefit.
In most cases, withdrawals made from IRAs before the age of 59 ½ require payment of an additional 10% tax. This tax can be waived if the distribution is used in the same year to pay for education expenses incurred by the taxpayer, their spouse, their child (including foster and adopted), and any descendant.
Note that the usual taxes will still apply to the distribution. It is only the additional 10% tax penalty that is waived.
Savings Bond Tax Exclusion - No Change
Some savings bonds can be cashed in for education expenses and the interest excluded from income.
Employer-provided Assistance for Education - No Change
This provision allows employers to provide education assistance to their employees, up to a maximum of $5,250 each year, tax free.
This can be a little complex, so taxpayers receiving education assistance should discuss it with their HR department to ensure they can receive these benefits tax free. This benefit is sometimes reported on the employee’s W-2 (Box 14), whereas taxable benefits get reported in Box 1. Alternatively, educational benefits are sometimes considered a fringe benefit - but they are usually excluded from income too.
Work-Related Deduction For Education - Eliminated
The tax bill eliminates the deductibility of employee-paid business expenses. Along with education, other expenses like uniforms and memberships are no longer deductible using Schedule A. The self-employed may still deduct these expenses using Schedule C.
In many cases, other tax benefits such as the AOC or Lifetime Learning Credit can still be claimed.
Deduction for Student Loan Interest - No Change
This deduction still allows taxable income to be reduced by as much as $2,500 by deducting interest on student loans that was paid within the tax year. Refinanced student loans are eligible as well. The money must have been used by the taxpayer, or their dependent, to attend school half time or more in a course of study for a certificate, degree, or credential.
This deduction phases out for higher-income earners.
Cancellation of Student Loans - Changed
Generally speaking, debt that is cancelled is considered taxable. Since many people who have their debt canceled do not have the cash to pay taxes on it, exclusions are important.
In the case of student loans, there are circumstances in which canceled debt is excluded from income. The loan is required to have provisions for cancellation of the loan when the student is employed 1) for a minimum time period, in 2) particular professions, and 3) works for particular types of employers.
A provision was also added for the tax-free cancellation of student debt caused by permanent disability or death.
Assistance for Student Loan Payment - No Change
Assistance with loan repayment is non-taxable when received as part of specific programs:
The National Health Service Corps Loan Repayment Program
- A state program that is eligible for funding under the Public Health Service Act
- Any state program whose purpose is to increase health services availability in areas with shortages of healthcare providers.
Saving For Education Expenses
Coverdell Education Savings Accounts - No Change
These accounts continue as they were before the new tax law. Although contributions are not deductible, Coverdell accounts grow tax-deferred until distribution. The contribution limit is $2,000 annually, with a phaseout for higher-income earners. Distributions used for education expenses - including elementary and secondary, along with higher education - are tax free.
529 Plans - Improved
The new tax law expanded the expenses that 529 plans are allowed to be used for.
Similarly to Coverdell accounts, the contributions to these plans are not deductible, but the contributions grow tax-deferred until distribution if they are used for educational expenses.
The new law added K-12 schools (whether public, private, or religious) to the list of eligible schools. Prior to the new tax law only higher education expenses could be paid with 529 plans. In addition, 529 plan balances can now be rolled into an ABLE account.
Note that some states offer state tax reductions for 529 plan contributions.
Educational expenses are some of the largest financial decisions a person can make. The changes put in place by the new tax law mean that taxpayers should examine their plans and make adjustments as necessary.