According to the National Student Clearinghouse Research Center, about 15.2 million undergraduate students enrolled in college for the 2023-2024 academic year.  Navigating the financial aspects of sending a dependent to college can be challenging, particularly when it comes to understanding the tax implications. While college expenses for a dependent are not directly tax deductible, there are several tax credits and deductions available that can significantly reduce the financial burden. 

This article will outline the main tax benefits, such as the American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit (LLC), as well as other options like 529 plans and student loan interest deductions. By leveraging these opportunities, you can make college expenses more manageable and reduce your taxable income.

Here are several tax credits and deductions available that can help reduce the overall tax burden related to college expenses:

Tax Credits

1 - American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a tax credit for eligible students to help cover the cost of higher education expenses. Here's how it works. For the first four years of college, you can receive a tax credit worth up to $2,500 per year for eligible student for expenses such as tuition, fees and course materials. As an added benefit, up to $1,000 of the credit is refundable, meaning you can get money back even if you owe no taxes. 

2 - Lifetime Learning Credit (LLC)

The Lifetime Learning Credit (LLC) is a tax credit to help offset the cost of higher education and continuing education. This tax credit is worth worth up to $2,000 per year for eligible education expenses like tuition and any required fees for post-secondary education and courses to acquire or improve job skills. This credit is not refundable though, so it can reduce your tax bill to zero but won’t give you a refund.

529 Plans

A 529 plan is a savings account designed to help families save for education expenses. Here’s how it works in simple terms. A parent, grandparent, or anyone can open a 529 plan account for a beneficiary, usually a child. You put money into the account. There’s no annual limit on how much you can contribute, but there are lifetime limits which vary by state.

These account have a couple advantages. First, the money you put in can grow over time, and you won’t pay taxes on the earnings (=tax-free earnings!). You can also take advantage of tax-free withdrawals. So, if you use the money for qualified education expenses, such as tuition, books, and room and board, you won’t pay taxes on the withdrawals.

However, you must spend funds from 529 accounts on qualified education expenses. These include costs for college, K-12 tuition (up to $10,000 per year), vocational schools, and some apprenticeship programs. The rules about what qualifies can vary, so it's important to check.

If you don't end up using all the funds in your account for your education, you have the flexibility to be able to change the beneficiary to another family member, like a sibling.

But a word of caution, if you use the money for non-educational expenses, you’ll have to pay taxes on the earnings plus a 10% penalty. A 529 plan helps you save money for education in a tax-advantaged way, making it easier to cover the rising costs of schooling.

Coverdell Education Savings Accounts (ESAs)

A Coverdell Education Savings Account (ESA) is another special savings account designed to help families pay for education expenses. A parent, grandparent, or another adult can open a Coverdell ESA for a child (the beneficiary). You can put up to $2,000 per year into the account until the child turns 18. The money you contribute is not tax-deductible, but it can grow tax-free and can be withdrawn tax-free if it's used for qualified education expenses, such as costs for elementary, secondary, and higher education, such as tuition, books, supplies, and sometimes even room and board.

The money in a Coverdell ESA must be used by the time the beneficiary turns 30. If it’s not, it must be transferred to another eligible family member or withdrawn, with taxes and penalties on the earnings. However, you can use the money for a wide range of educational expenses, from kindergarten through college and even some special needs education.

Student Loan Interest Deduction

Impact on Taxable Income

Tax credits for college tuition can directly reduce your tax liability, which can be more beneficial than deductions. But deductions can also be used to lower the amount of tax you owe. Be sure you are aware of the income limits for each credit and deduction as your eligibility may be reduced or eliminated if your income is above certain thresholds. You might also consider utilizing multiple tax benefits if eligible, such as combining the AOTC with a 529 plan for different qualified expenses.