Educational Expenses and Credits (Portfolio 517)

Description

Tax Management Portfolio, Educational Expenses and Credits, No. 517, addresses the income tax treatment of expenses for postsecondary education. In general, the tax benefits discussed in this Portfolio apply when a taxpayer pays educational expenses for the taxpayer or the taxpayer’s spouse or claimed dependents. Educational expenses may be deductible as business expenses or under a special deduction for tuition and fees. Alternatively, two education credits allow taxpayers to claim a credit for qualifying payments of tuition and related expenses. In addition to the deductions for payments of tuition and related expenses, another education-related deduction applies to interest on student loans. For each deduction and credit, there are numerous requirements for eligibility. Moreover, except for the business expense deduction, the deductions and credits for educational expenses are limited in amount and do not apply to taxpayers with higher adjusted gross incomes.

The first part of this Portfolio contains an introduction that shows how the deductions and credits discussed in this Portfolio relate to other education tax and non-tax benefits. In general, the education tax benefits are mutually exclusive. Thus, a taxpayer can use the deduction, credit, or exclusion that produces the maximum tax savings.

Educational expenses may be deductible as business expenses or qualified tuition and related expenses. To qualify for deduction as a business expense, an educational expense must be an ordinary and necessary expense paid or incurred in carrying on a trade or business. In addition, the education must either maintain or improve skills required in the taxpayer’s employment or other business or meet the express requirements of the taxpayer’s employer, or of applicable law or regulation, imposed as a condition to the retention of the taxpayer’s established employment relationship, status, or rate of compensation. Even if the deduction requirements are satisfied, a business expense deduction is disallowed if the expenses are for education required to meet the minimum requirements of a taxpayer’s trade or business or that is part of a program of study leading to the qualification of a taxpayer in a new trade or business. The deduction of travel expenses for education is prohibited or limited. The deduction of educational expenses as business expenses is discussed in Part II.

Educational expenses that do not meet the requirements for deduction as business expenses are considered nondeductible personal expenses, unless they qualify for a limited deduction for tuition and related expenses. Instead of deducting educational expenses, a taxpayer may claim one of two education credits: the American Opportunity Tax credit (or, for pre-2009 and post-2017, the Hope Scholarship Credit) or the Lifetime Learning Credit. The deduction for tuition and fees and the education credits generally apply to the same type of expenses: payment of tuition and fees incurred by an eligible student for higher education at an eligible educational institution. The requirements and limitations applicable to the deduction for tuition and related expenses and the education credits are discussed in Parts III and V, respectively. Those with student loans can derive a relatively small benefit from deducting interest paid on qualifying student loans obtained solely to pay qualified higher education expenses. The deduction for interest on student loans is discussed in Part IV.

Qualified scholarships and qualified tuition reductions, qualified tuition programs, Coverdell Education Savings Accounts, penalty-free withdrawals from IRAs for amounts used to pay qualified higher education expenses, forgiveness of student loans, and information reporting requirements related to higher education tuition and related expenses are discussed in 518 T.M., Exclusion of Scholarships and Other Receipts for Education.

Table of Contents

I. Introduction
II. Exclusion of Scholarships, Fellowships, and Other Receipts for Education
III. Deduction of Educational Expenses Under 162
IV. Qualified Tuition Programs
V. Coverdell Education Savings Accounts
VI. Tax Credits for Higher Education
VII. Interest on Educational Loans
VIII. Penalty-Free Withdrawal from IRA
IX. Forgiveness of Student Loans
X. Deduction for Qualified Higher Education Expenses
XI. Information Reporting Requirements