How College Costs and Financial Aid Affect Tax Returns

Record expenses and aid carefully so you can claim the proper credits

Students listening to teacher in class

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In addition to the stressful work of applying to college, completing a FAFSA every year, and learning about financial aid, parents of college students have to be aware of the income tax implications of every step they take.

While there are certain tax credits and deductions available that can help lessen the impact of paying for college, the IRS can be a little picky about the documentation it requires to substantiate those claims. You certainly want to claim all the deductions you can, but you don’t want to raise any potential red flags, either. Here are a few steps you can take to ensure your tax forms are filled out properly.

Record Money You Receive

If you received money to pay for college expenses, whether in the form of a scholarship, grant, or withdrawals from a 529 plan, you'll need to record these properly on your federal income tax return. To help you, you'll receive forms from various entities involved.

For example, the college will send the tuition-paying student (or you, if the student is your dependent) a 1098-T, which will detail the amount of tuition, grant, and scholarship assistance your student has received.

Students (or their parents) who have made withdrawals from a 529 investment or prepaid plan or a Coverdell Education Savings Account may receive a 1099-Q: Payments From Qualified Education Programs. The form will show you the total amount of distributions for the year (even if it didn't all go directly to the school).

Make sure that the distributions are made in the student’s name, not yours, or you may be required to claim them as taxable income.

If your student received financial assistance from other sources, such as an employer or the Veterans’ Administration, document that carefully as well.

Claim the Proper Tax Credits

You may be able to claim a tax break such as the Lifetime Learning Credit or the American Opportunity Tax Credit if you meet qualifications.

Lifetime Learning Credit

The Lifetime Learning Credit can be claimed by the student or the student's spouse or parent. It provides for a deduction up to $2,000 if the student is enrolled at an eligible institution and taking courses toward a degree or to improve job skills. The credit phases out when you have an adjusted gross income (AGI) of $58,000 ($116 for joint returns) and is unavailable if your AGI is over $68,000 ($136,000 for joint returns).

American Opportunity Tax Credit

The American Opportunity Tax Credit is a credit of up to $2,500 toward expenses for eligible students in the first four years of earning a degree. If your credit pays your taxes down to zero, you also can get a refund of up to $1,000 of the remaining credit. To claim the credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 if married filing jointly), with an adjusted amount for filers with a MAGI of up to $90,000 ($180,000 if married filing jointly).

The IRS provides a tool to help you discover whether you qualify for educational credits.

Deduct Qualified Education Expenses

If you made withdrawals from a college savings plan or are claiming a tax break, you will need to know what expenses count as qualified education expenses to the IRS.

In general, qualifying expenses include normal costs of attendance, such as:

  • Tuition
  • Required fees
  • Course-related expenses such as books and supplies

Expenses which usually do not qualify include:

  • College application fees
  • Room and board
  • Transportation
  • Student health insurance and medical expenses
  • Student fees (unless they are required as a condition of enrollment or attendance)

Be aware of what money you use to pay for college expenses. You can't "double-dip"—that is, you cannot claim an additional credit for expenses that you paid with a scholarship, grant, tax-free distribution, or a tax-free educational assistance program.

Keep Supporting Documentation

The best way to survive an audit if you are selected is to be able to provide documentation for everything. Receipts and other documents help you prove that the money was spent on qualified educational expenses.

Maintain copies of all receipts or canceled checks, and have copies of class transcripts on hand as well to show that your student actually completed specific courses.

Keep copies of each course syllabus so that you can justify purchasing required books or materials, and keep receipts for those purchases. If you paid out-of-pocket for computer equipment and technology or internet access, maintain documentation for that as well.

You may want to use a separate checking account or credit card to pay for college expenses so that they will be easier to track.

Fill out Your Return Carefully

Don’t speed over this portion of your tax return. Take your time, transfer numbers carefully from your 1098s and 1099s, and check your math twice. You don’t want a simple error to result in an audit. Tax preparation software can help you with your calculations and often provides an additional math guarantee as well.

If you received a refund from the college, be sure to subtract that from any amounts you are claiming.

Get Help if Needed

Preparing your taxes while you or your dependent is in school can be quite confusing, and it might be advisable to work with a tax preparation professional. The amount you invest in having someone else make sure your tax returns are completed correctly could be well worth it if you don’t have to deal with the stress of an IRS audit.

Article Sources

  1. TurboTax. "Guide to Tax Form 1098-T: Tuition Statement." Accessed May 26, 2020.

  2. TurboTax. "Guide to IRS Form 1099-Q: Payments from Qualified Education Programs." Accessed May 26, 2020.

  3. H&R Block. "Is Income Reported on Form 1099-Q Taxable?" Accessed May 26, 2020.

  4. IRS. "Lifetime Learning Credit." Accessed May 26, 2020.

  5. IRS. "American Opportunity Tax Credit." Accessed May 26, 2020.

  6. IRS. "Qualified Educational Expenses." Accessed May 26, 2020.

  7. Fidelity. "How to Spend From a 529 College Plan." Accessed May 26, 2020.