Education Costs 101: Tax-saving ways to pay for school

Kids of all ages are back in class. Now comes the fun part: Figuring out how to pay for all that book learning.

Why not let a relative help? Your good ol’ Uncle Sam.

For the last decade, a variety of federal tax breaks have been around to help us pay for higher education for ourselves, our spouse or our dependents.

The good news is that there are so many educational tax break options.

The bad news is that there are so many educational tax break options.

Many, but with limits: Uncle Sam is helpful, but not too helpful. He doesn’t like us double dipping when it comes to tax breaks, even when they’re for a good cause such as furthering our educations. That means that in most cases the same student is not
allowed to use two different education tax breaks in the same tax year.

So you have to choose the tax code provision that benefits you most. A credit, which lets you reduce your tax bill dollar-for-dollar, usually is better. But, and you knew that was coming since this is about taxes, everyone’s situation is different, so a deduction might be the better choice for some.

But even with the added work and one-only restriction, the tax code can definitely come in handy in helping you meet at least part of the costs of college and, in some instances, pre-college costs. Even teachers still get a minimal tax break.

Below are some of the more popular federal tax breaks. Just click on them for more information.

• Hope Scholarship Credit
• Lifetime Learning Credit
• Coverdell education savings accounts
• Student loan interest deduction
• Deductions for higher education tuition and fees
• Classroom expenses deduction
• Savings Bonds redeemed for college costs

Don’t forget about 529 plans. My earlier post on this topic discusses the advantages of these tax-favored college savings accounts.

And if you’re really strapped, you can use your IRA money to pay college costs. It’s an extreme option, so check out all your other options before you rob your retirement account. But it’s there. You’ll owe any applicable taxes on your IRA distribution, but you at least can avoid the 10 percent penalty for the withdrawal.

Other student aid avenues: More new educational help is on the way from
Uncle Sam. Congress has sent the College Cost Reduction and Access Act of 2007 to Dubya for his signature. Once it becomes law, it will provide $18 billion over the next five years for student aid.

Lauren at The Huffington Post looks at how this measure will help students struggling to pay their bills as well as make their grades. U.S. PIRG also offers an analysis of the proposal here.

But it’s not all sweetness and light, says Monique at Student Loan Info for Parents. She notes the good, bad and ugly parts of the bill.

Your boss might be able to help, too. Under a qualified employee benefit plan, up to $5,250 per year can be
provided to an employee as reimbursement for educational expenses. This includes tuition, fees, books, supplies and tools. The education doesn’t have to be related to the job, or even part of a degree
program, although some employers may impose such requirements.

And don’t forget about state tax savings. Many offer tax breaks similar to the federal ones, so check with your state revenue department and your school’s financial aid office.

Extra credit reading: The National Association of Tax Professionals has some educational tax break advice in this release.

You can get the official word from the IRS on educational tax breaks in this announcement, as well as at Tax Topic 605 and Publication 970. 

I know it’s a lot of homework. But at least in this case, the extra effort to find the right tax break for you and your student could show up as added money in your bank account.

And that’s a definite A+.