How College Costs and Financial Aid Affect Tax Returns

Keep track of financial aid and expenses to reduce audit potential

Students listening to teacher in class
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Nobody ever said that having children in college was going to be easy. In addition to the stressful work of applying to college, completing a FAFSA every year, and learning about financial aid, parents 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 reduce your tax audit potential.

Gather Your 1098s

You may receive 1098 statements from various entities that you will need to refer to in completing your federal income tax return. The college may send a 1098-T, which will detail the amount of tuition, grant, and scholarship assistance your student has received.

Parents who have made withdrawals from a 529 investment or prepaid plan, or a Coverdell Education Savings Account, may receive a 1099-Q. Make sure these distributions are made in the student’s name, so it doesn’t show up as additional income for you. If your student received financial assistance from other sources, such as an employer or Veterans’ Administration, be sure to document that carefully as well.

Learn What You Can and Cannot Deduct

If you made withdrawals from a college savings plan or are claiming a tax break such as the Lifetime Learning Credit or the American Opportunity Credit, you will need to know what is deductible and what is not.

In general, qualifying expenses include normal costs of attendance, such as tuition and required fees. You may also be able to claim expenditures for course materials such as books, supplies, and equipment needed for a course of study. Expenses which usually do not qualify include college application fees, room and board, transportation, student health insurance and medical expenses, and student fees unless they are required as a condition of enrollment or attendance.

Don't Double Dip

Be aware of where the money originated that you use for college expenses. 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.

Document Everything

It may take a little more time, but the best way to survive an audit, should you be selected for one, is to be able to provide documentation for everything.

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

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

If your student lives off-campus, be prepared to substantiate the college’s traditional room and board allotment. 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.

Work Carefully

Don’t speed over this portion of your tax return. Take your time, transfer numbers carefully from your 1098s, and check your math twice. You don’t want a simple error to call attention to you. If you received a refund from the college, be sure to subtract that from any amounts you are claiming.

Get Help

Yes, it is confusing, and that is why 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.

Completing tax returns always has its own unique form of pressure. Try to lessen your stress by getting organized and taking your time.