Caution on college debt deductions


There remains myriad potential tax benefits for students, and parents of students making payments for college tuition and/or towards student loan indebtedness. But making sure the benefit is on the right return and giving the taxpayers the biggest bang for their buck isn’t always cut and dry.

College students still are eligible for the American Opportunity Credit for tuition paid in the first four years of post-secondary education. Student fees required for enrollment also will qualify for the credit. Schools typically issue a 1098-T in the student’s name reporting payment made to the school for the year that will fall into the qualified tuition category.

If parents are continuing to claim the student listed on the 1098-T as a dependent then the credit may be able to be claimed on the parents Form 1040.

But preparers need to consider who receives the larger benefit for these tax credits. The American Opportunity Credit is limited based on income and in many situations parent returns may have the credit phased out because their income is too high.

While, parents may potentially forgo other benefits for not claiming their son or daughter on their return, the child filing their own tax return in order to receive the full AOTC could outweigh the alternatively. Making sure to look at the differences is providing your clients with a higher quality service.

Unlike tuition payments, interest on student loan indebtedness is not so flexible and preparers need to be wary of who’s return the interest is being claimed on. Many parents take out student loan debt to pay tuition on their children’s behalf but the ability to deduct the interest depends on who the loan is actually written to.

When loans are written to the student themselves, the student is the only taxpayer entitled to claim the interest as a deduction on their Form 1040. This is regardless of parents who may choose to make the loan payments on their child’s behalf. Preparer’s need to pay close attention to which return interest is claimed on.

Similar to the above, it may be advantageous in this situation for students to begin filing their own tax returns, but all factors need to be considered.

Non-tax factors could also play a role, such as parents still claiming their dependent children for insurance purposes or even financial aid for schools. The best way to assist taxpayers in these scenarios is to have a holistic conversation with them about these different variables and calculate the differences in tax liabilities across multiple scenarios.

College tuition and student loan debt tend to get swept under the rug of tax returns being prepared the same way they were last year without any simple analysis being done to determine the best outcome for the taxpayers. These simple conversations will certainly set you apart from your competitors in terms of service to your clients.

Like what you’re reading?

Subscribe to our FREE newsletter and we’ll deliver content like this directly to your inbox.