The cost of college attendance has increased by almost eight times in the last 20 years. The federal government encourages continuing education by offering tax credits and deductions.
We’ve put together 7 tax credits and deductions that you can use as a recent college graduate or student to reduce your tax bill.
Table of Contents
What is the difference between a tax credit and a tax deduction?
- Retirement Account Contributions
- Capital Gain Losses
- American Opportunity Tax Credit
- Lifetime Learning Credit
- Tax Credit for Recovery
- Student Loan Interest Deduction
- Earned Income Tax credit
What is the difference between a tax credit and a tax deduction?
Tax deductions can reduce your taxable earnings. If you are a single taxpayer earning $50,000 and claim a $1,000 tax deduction, your net taxable earnings will be $49,000. This income puts you in the 22% tax bracket. You will save $220 on taxes.
Tax credits reduce your tax liability by dollar for dollar.
Take the same example as before. You will pay federal income tax of $6,790 if you earn $50,000 adjusted gross income. A $1,000 tax credit will reduce this by dollar for dollar, so you only owe $6,790. Tax credits are therefore more valuable than tax deductibles.
- Contributions to Retirement Accounts (IRA)
While it may seem strange to begin with retirement when just beginning your career or having a weekend job is all you have, this can be a valuable tax break for students over the long term. Do your research on the stock market before choosing a trading app.
The tax code rewards this behavior, allowing you to deduct contributions from your taxable earnings if they are made into a traditional IRA. Contributions are limited to $6,000 or your annual earned income.
You can get some insight into your 401k and IRA by using Blooom. Blooom is free and you can use it to receive portfolio recommendations, find hidden fees, etc.
- Capital Gain Losses
You will hopefully only gain if you trade stocks on a tax-deductible account. We live in a real world.
Not all our investments will be winners. You may be able start investing earlier than 21 depending on where you live.
You can use the tax losses you receive when you sell losing positions to reduce your taxable income. You can claim losses up to $3,000 against your income and offset capital gains.
Capital losses can be carried forward until they are offset by capital gains or the maximum $3,000 deduction for earned income is reached.
- American Opportunity Tax Credit
You may be able to claim an American Opportunity Tax Credit (AOTC) if you have paid for your college expenses yourself, including tuition fees and other higher education expenses. This could lower your tax bill by dollar for dollar.
This credit is worth up to $2,500 a year if you are enrolled at least 50% time and working toward a degree.
You can claim up to $2,500 in total by claiming the first $2,000 of eligible expenses, plus 25% or $500 of the next $2,000 (totaling $2,500).
- Lifetime Learning Credit
This tax credit is similar to the American Opportunity Tax Credit in that it lowers your taxes dollar for dollar. However, only one claim can be made.
The Lifetime Learning Credit is a way to pay for graduate or professional degrees.
This credit is not subject to a minimum enrollment requirement (meaning that you do not need to be enrolled full-time) and you aren’t required to earn a degree.
If you decide to go back to school in the future to earn more credentials, or if you need to continue your education to maintain your license, you can use the Lifetime Learning Credit on your tax bill.
- Tax Credit for Recovery
Many Americans received a stimulus payment as part of the CARES Act. You can claim the Recovery Rebate Tax Credit if you weren’t claimed on a tax return for 2020 and didn’t get a stimulus check.
These payments were received as an advance payment last year, but they are technically a tax credit for your 2020 return.
- Interest on Student Loans
You can deduct interest on student loans if you are one of the 42 million Americans who have outstanding student loans.
You can claim this deduction if you have paid student loan interest of at least $600 during the calendar year. The maximum amount that you may deduct is $2,500 per year. As with most of the credits and deductions listed, you must meet income requirements to claim this credit.
- Earned Income Tax credit
You may qualify for the earned-income tax credit if you are an older student who earns a low to moderate income.
You can still claim the earned income credit even if you have a negative balance if you’re tax bill is below zero dollars (meaning that you should be due a refund).
If you owe $2,000 in tax before you claim the earned income credit, but it is worth $2,500, you will have a negative tax liability of $500. This can be returned to your account via a refund.
This article was originally published on Wealth of Geeks. It has been republished by permission.
