Sending Kids to College

The big day has finally arrived. Your son or daughter applied to colleges, sifted through the acceptance letters and decided where to spend the next four (or five or more) years. Now all you have to do is figure out how to pay for it. Luckily, Uncle Sam offers several ways to ease the sting of rising tuition costs. Which tax breaks work for you will depend on your income, your child's student status, and the source of your education funding.

The most generous tax breaks for college costs are the Hope and Lifetime Learning Credits, which offset your tax-bill dollar-for-dollar compared to a tax deduction that merely reduces the amount of income subject to tax. You can't claim both credits for the same student in the same year, and income limits restrict who can use them.

For 2008, you can claim a Hope Credit of up to $1,800 if your student is in his or her first or second year of college and your income doesn't exceed $96,000 if you are married filing a joint return ($48,000 for individuals.) The credit is based on 100 percent of the first $1,200 of qualifying college expenses and 50 percent of the next $1,200. There's no limit on the number of Hope credits you can claim in any year.

If you have triplets who are freshmen in college, for example, you can qualify for $5,400 of credits. The Lifetime Learning Credit—which can be as much as $2,000, based on 20 percent of up to $10,000 of qualifying higher-education expenses—is available for an unlimited number of years for any degree or non-degree course. But you can only claim one Lifetime Learning Credit per year, no matter how many students you have in your household. You cannot claim the both a Hope and a Lifetime Learning Credit for the same student in the same year. The same income limits apply to the Lifetime Learning Credit as for the Hope Credit.

If you earn too much to claim the Hope or Lifetime Learning Credit and your student has some income of his or her own, you can elect to forego the dependency exemption, let your student file his or her own tax return, and claim the education credit. The student does not get to claim the dependency exemption, but the value of the education credit may make it preferable for the family to forfeit the exemption, particularly if your income is so high that the value of the exemption is reduced.

Another option is a tax deduction of up to $2,000 or up to $4,000 of qualified tuition and related fees, depending on your income. The above-the-line tuition tax deduction allows married couples with incomes of $130,000 or less ($65,000 for individuals) to deduct up to $4,000 in higher education expenses, and those couples earning $130,000 to $160,000 ($65,000 to $80,000 for individuals) to deduct up to $2,000. You do not have to itemize your deductions to claim the tuition and fees deduction, but you cannot claim the deduction in the same year you claim the Hope or Lifetime Learning Credit.

You can take tax-free distributions for qualified education expenses from your child's 529 College Savings Plan or Coverdell Education Savings Account, formerly known as education IRAs. You can use tax-free withdrawals from Coverdell ESAs and 529 College Savings Plans in the same year as the Hope or Lifetime Learning Credits as long as you don't use them for the same expenses.

Interest earned on Series EE or Series I Savings Bonds issued after 1989 is tax-free if the bond is used for college tuition and fees. The tax break begins to phase out for married couples with incomes above $100,650 ($67,100 for other returns). The phase-out level for 2009 will begin at $104,900 for joint returns ($69,950 for other returns). The tax-free Savings Bond provision cannot be combined with other educational tax breaks such as the Hope or Lifetime Learning Credits or tuition deduction.

TurboTax can help you take advantage of a wide variety of tax breaks on college costs.

Updated for tax year 2008