Education tax credits and deductions and FAFSA money! Oh my!

If you received financial aid in 2019, you may need to report those funds on your tax return depending on how you used the money. Each financial aid award is treated a little differently, so we’ll aim to unpack each one. We’ll also take a look at higher education tax credits and a deduction you should know about. Let’s dive in.

That moment your FAFSA money becomes taxable

Pell grants

In order for a Pell grant to remain tax-free, you can only use the funds to pay for tuition, fees, books, supplies and equipment. However, if you use the funds to pay for housing and meals, or even school-related travel expenses, then you must include the portion of the grant you used to pay these expenses in your taxable income.

Scholarships and fellowship grants

Just like a Pell grant, scholarships and fellowship grants are tax-free when used to fund tuition, enrollment fees and other qualified education expenses, which include expenses like fees, books, supplies and equipment that are required (of all students) for your courses. Qualified education expenses do not include the cost of housing, meals, travel, research, clerical help, equipment and other expenses that aren't required for enrollment.

So in the case of Pell grants, scholarships and fellowship grants, if your award covered tuition, housing and meals, the amount you use for tuition is tax-free. However, the amount you used for housing and meals is taxable.

Work-study earnings

Although you may have been awarded Federal Work-Study to help pay for college, the money you earn at your work-study job must be reported as income just like any other employment earnings. Include these earnings with your wages and salary.

Government student loans

A student loan is not considered to be taxable income because you, as the recipient of the loan, have to pay it back (with interest). When you begin repayment, you may qualify for a student loan interest deduction (more on that in a second) if your income is not too high and you use the funds only for school-related expenses while in college. If, however, any amount of a student loan is forgiven, that amount would become taxable income for that year.

 

Education tax credits and deductions

A tax credit reduces, dollar-for-dollar, any amount of money that you owe to the government. Got $1,000 in tax credit and owe the government $2,000? Well, now you owe only $1,000. A tax deduction reduces the amount of your income that is subject to being taxed.

American Opportunity Tax Credit

The American Opportunity Tax Credit can be used each year of your first four years of college. You must be enrolled at least half time. The credit is worth up to $2,500 per year for money paid toward tuition, enrollment fees, course-related books, supplies and equipment that are not necessarily paid to the educational institution but are needed for attendance. It does not cover housing and meals.

Another bonus is that 40% of the credit is refundable — that means that if you end up not owing anything on your taxes, you can still get up to $1,000 back. The credit will phase out for taxpayers making more than $90,000 a year on their own, or $180,000 a year for married couples. Any felony drug convictions by the end of the tax year disqualify the student from receiving this credit.

Lifetime learning credit

Another popular tax credit is the lifetime learning credit, which can be claimed by the student, the student’s spouse or the student’s parent. It can be claimed for a deduction of up to $2,000 per household, but not by the same student if he or she has claimed a different tax credit within the past year of their claiming the Lifetime Learning Credit. If the taxpayer’s income exceeds $47,000, this credit won’t apply.

Tuition and fees deduction

This deduction applies to your qualified education expenses paid during the year for yourself, your spouse or your dependent. The Tuition and Fees Deduction (Form 8917) can reduce the amount of your taxable income by up to $4,000. You cannot take this deduction if you are taking one of the education credits we discussed above.

Student loan interest tax deduction

If you’ve been paying interest on your student loans, the student loan interest tax deduction is for you. You can deduct up to $2,500 each year of student loan interest that you paid on a qualified student loan as long as you are enrolled at least half time and are working toward a degree. A qualified loan means that you borrowed your student loan solely to pay for education expenses and did not borrow the student loan from a relative or through a qualified employer plan. Examples of qualified education expenses include tuition and fees, housing and meals, books, supplies, equipment and transportation, among other necessary expenses.

You can use the IRS’s Interactive Tax Assistant tool to help determine if you’re eligible for any of the education credits or deductions we covered.

 

So, how do I know what my qualified expenses were?

Great question. Your IRS 1098-T form is available on My ASU (Finances tab > Account Charges box > IRS-1098-T). You can also find explanations for the supplemental forms and 1098-T FAQs here. It will report the amounts billed to you for qualified tuition and related expenses, as well as other related information. You, or the person who may claim you as a dependent, may be able to claim an education credit on form 1040 or 1040-A for the qualified tuition and related expenses that were actually paid during the calendar year.

Whew, that was a lot. But it’s totally worth it to educate yourself on any potential savings you may be entitled to. Stay tuned tomorrow for a look at life after you file … the dreaded tax penalty, or the glorious tax refund. Fingers crossed you fall into the latter group!

Each person’s tax situation depends upon individual circumstances. The information in this article is intended to serve as introductory tax information. Tax professionals should be consulted for personalized tax advice.