Raising your child from infancy and guiding them along life’s journey to prepare them for college is a commitment that takes years and thousands of dollars to sustain. Fortunately, Uncle Sam offers tax breaks for parents a way to soften this financial hardship during tax season.
There are a number of ways parents of college students and college-bound students can save money with the support of federal tax credits and deductions. This guide reviews a few ways your kids can help you save money on your taxes.
How to Save Money on College-Specific Tax Credits and Deductions
Let’s face it, college costs are continually rising which can make funding your child’s education that much more challenging. These tax credits and deductions can help you save considerable cash as you prepare your tax return.
Education Tax Credits
There are two federal education tax credits you might not be aware of:
These educational tax credits are similar in some ways and different in others. For example, you’re unable to claim either credit if you are claimed as a dependent on someone else’s return. The AOTC is available for college-related expenses, like tuition and fees and textbooks, and offers a $2,500 credit per eligible student, while the LLTC offers a maximum benefit of $2,000 per return.
The AOTC is claimed mostly by parents of undergraduate students, while the LLTC is more common among graduate students and continuing education students.
Student Loan Interest Deduction
If you paid student loan interest in 2018 on a qualified student loan, you might be eligible for the Student Loan Interest Deduction. Qualified education loans include most federal and private student loans. Taxpayers who meet certain income requirements may deduct up to $2,500 in student loan interest.
529 College Savings Plans
A 529 college savings plan is a tax-advantaged savings account that earns tax-free interest when distributions are used to pay for your child’s educational expenses. Currently, contributions may be used for college costs and private school tuition for grades K-12. Many states offer income tax deductions or credits based on your contributions.
Employer-Paid Tuition Assistance
The Employer-Paid Tuition Assistance program allows for a maximum of $5,250 in excludable income each year. Keep in mind that you’re unable to apply this tuition expense paid by your employer toward other education tax credits or deductions. The IRS does not allow double-dipping.
Tax-Free Student Loan Forgiveness
Under current law, up to $5,250 in employer-paid education assistance is not counted as taxable income to an employee. The CARES Act added employer student loan repayment assistance in the definition of employer-paid educational assistance.
So, today, and through 2025, an employee can receive a total of $5,250 in combined education assistance and loan repayment assistance tax-free. (Note: education assistance only applies to the employee’s education expenses, not for a spouse or child).
Federal student loan forgiveness programs including Public Service Loan Forgiveness (PSLF), Teacher Loan Forgiveness, and loan forgiveness programs established by the Public Health Service Act, are also tax-free.
Education Savings Bonds
You can use education savings bonds to pay higher education expenses or to fund a 529 education savings plan to avoid taxes on earned interest.
Moving cash to a 529 plan also provides the added benefit of dodging income phase-outs and the transferred funds can be used to pay for a wider range of qualified expenses.
Other Tax Breaks for Parents
Outside of claiming tax credits and deductions for higher education costs, as a parent you have additional tax advantages to consider.
Child Tax Credit
The Child Tax Credit recently doubled and is now as much as $2,000 per child under age 17, and is refundable up to $1,400 per child. A nonrefundable $500 tax credit is available for dependents who are not eligible for the Child Tax Credit.
Another notable change from prior tax years is the income phase-out limit associated with this credit. For the 2020 tax year, the phase-out is $200,000 for single filers and $400,000 for joint filers.
However, as part of the COVID-19 relief efforts, the IRS allows taxpayers to use 2019 income for the 2020 tax year if it helps them get a bigger tax credit.
Childcare Tax Credit
You might be able to claim the Child and Dependent Care Tax Credit if the expense for care — whether a summer camp, baby-sitter, daycare, etc. — enabled you to work or look for work. Care must be provided for a child who age 13 or younger, or a spouse or other individual who is incapable of self-care.
The amount of the tax credit is based on 20% to 35% of a maximum of $3,000 in child care expenses ($6,000 for two or more dependents) during a given tax year.
Adoption Tax Credit
The Adoption Tax Credit offers eligible parents a maximum of $14,300 tax credit per child in 2020 for qualified costs associated with adopting each child. If the credit exceeds your tax liability, you’re allowed to transfer the remaining credit to future tax years for up to 5 years.
Invest the Tax Savings
When saving money using these non-college-based tax credits, consider contributing the funds into your child’s 529 college savings plan to maximize your savings.
Single Parent Filing as Head of Household
If you’re eligible, filing taxes as “Head of Household” can help you save money on your taxes by lowering your taxable income with a higher standard deduction and broader tax brackets for lower tax rates.
The criteria for filing as Head of Household include:
- You must have paid for more than half the cost of keeping up your home, such as rent, mortgage interest, utilities, property taxes, homeowner’s insurance, and maintenance,
- You must be unmarried or considered unmarried on the last day of the tax year, and
- You must have a child or other dependent relative who lived with you in the home for more than half the year, or you claim a parent as a dependent
If you feel you fit the above requirements and have been filing your taxes as “single”, speak to a reputable tax professional to see if you could benefit by filing as Head of Household. IRS Publication 17 also discusses the requirements for head of household status.
Although again, it’s not quite a credit or deduction on your tax return, it’s good to know the threshold for the “Kiddie Tax”. The first $1,100 of a child’s unearned income is tax-free, and the next $1,100 is subject to the child’s tax rate. Any additional earnings above $2,200 are taxed at the child’s parents’ marginal tax rate.
Being aware of all the college- and child-specific tax credits and deductions you’re eligible for can help you save money when filing your taxes.