Quick, study these tuition tax breaks before the exam

Joe and Melody Sheridan had no idea that the federal government would help them finance their 21-year-old daughter’s college education until a few weeks ago, when a tax-savvy friend happened to mention it.

“This means that we may be able to save a little -- and not deplete our savings account so much,” said Joe. The fact that he would have completely missed a $4,000 deduction if not for this coincidence is tragically common, tax experts say.

The U.S. Government Accountability Office reported late last year that 27% of eligible filers missed lucrative deductions and credits aimed at helping middle-class parents defray the cost of higher education.

“It can be an informational breakdown,” said Philip J. Holthouse, partner in the Santa Monica tax accounting firm of Holthouse, Carlin & Van Trigt. “If you give your return to a preparer, there have to be some questions back and forth before you can flesh out all the deductions and credits that you are entitled to.

“Force that conversation with your accountant if they don’t initiate it,” he added. “Your accountant may be focused on filing, rather than figuring out what information they didn’t get from you.”

Sheridan said he never had thought to ask about tax credits for college.

Until recently, his daughter, Ricci, had been going to school on an athletic scholarship. But an injury caused her to switch institutions and lose that free ride. Now, the North Carolina-based schoolteacher said he has been draining savings accounts to pay the $14,000 annual cost of Ricci’s education.

“The tax breaks offered to students and their families serve as additional sources of financial aid,” said Rob LaBreche, president of consumer marketing for College Loan Corp., a San Diego-based student lender. “It’s tragic that so many parents miss them. Families who don’t take advantage of the tax breaks are missing out on hundreds, and sometimes thousands of dollars. It’s just a matter of knowing that they are out there.”

There are three major tax breaks for those paying college bills, and there are several minor breaks that parents may also qualify for, said Mark Luscombe, principal federal tax analyst with CCH Inc., a Riverwoods, Ill.-based publisher of tax information. Figuring out which are available and how they can be used is no easy undertaking, however.

In many cases, using one break precludes use of another. And for nearly all the tuition tax breaks, you lose the ability to claim them once your income exceeds certain thresholds.

What are the breaks and who can qualify?

There are two types of breaks -- tax credits and tax deductions. Credits are usually the most valuable because a deduction simply reduces the taxpayer’s taxable income, while a credit is a dollar-for-dollar reduction in taxes due.

In other words, a $1,000 deduction would save someone in the 25% tax bracket about $250, while a $1,000 credit would save that person $1,000.

In this case, however, the deduction is more widely available because the acceptable income thresholds are higher.

Specifically:

* The “tuition and fees deduction,” which is the benefit that Sheridan almost missed, is a so-called “before the line” write-off. It allows parents to deduct 100% of their cost of tuition and fees up to a maximum of $4,000 a year.

Because this deduction reduces adjusted gross income, it can help parents qualify for other deductions and credits that are phased out at higher income levels, including tuition credits for a second college student.

Parents earning up to $65,000 if single and $130,000 if married get the maximum amount. There are smaller deductions for singles earning up to $80,000 and marrieds with income of $160,000 or less.

The line listing this deduction also disappeared from the 1040 this year. Taxpayers who qualify must write it in on line 35.

* Hope tax credits of as much as $1,650 can be claimed to defray the first $2,000 in tuition bills run up by a freshman or sophomore in college. Full credits are available to singles earning up to $45,000 and married couples earning up to $90,000. Smaller credits are available for some people who earn more. But once adjusted gross income exceeds $55,000 when single or $110,000 when married, the credit evaporates.

* Lifetime learning credits of as much as $2,000 are available to those paying college bills no matter your age or your year of study. This credit has the same phase-out levels as the Hope Tax credit, but it’s calculated differently.

Taxpayers claim 20% of their qualified expenses of up to $10,000. Consequently, if they have just $5,000 in qualified expenses, their credit is limited to $1,000.

How do you choose between the tax breaks if you qualify for them all? The best break is almost certain to be a credit, tax analyst Luscombe said. But whether the Hope or the Lifetime Learning credit provides the best write-off will depend on the amount of qualified expenses.

The Hope credit provides the highest percentage write-offs, making it the best bet for those with college bills of $8,250 or less.

Those who spend more on tuition and fees would get a bigger write-off by claiming the Lifetime Learning credit.

Meanwhile, parents who earn enough to be affected by the phaseouts may want to play with the numbers a little bit, particularly if they have more than one child in college.

In some cases, claiming the deduction for one child could allow them to get a bigger credit for a second student, Luscombe said.

Other college-related tax breaks:

* Money withdrawn from a 529 or a Coverdell account that’s used to fund college bills is tax-free.

* Student loan interest is tax deductible up to a maximum amount of $2,500 annually. This deduction phases out once single income exceeds $50,000 and joint income exceeds $105,000. Notably, if a parent repays a student’s (or former student’s) college loans, the repayment is now considered a gift to the child and the child can take the interest deductions on his or her return.

Parents who want more information about college-related tax breaks can get IRS Publication 970 by calling 800-829-1040 or by visiting www.irs.gov. College Loan Corp. also offers a free booklet that parents can get by calling 800-2-COLLEGE or by visiting www.collegeloan.com.

Kathy M. Kristof welcomes your comments, but regrets that she cannot respond to every question. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes .com/kristof.