Higher Education Tax Benefits
In addition to loans and grants, the federal government offers a series tax benefits to students and their families to help lessen the cost of higher education. There are twelve higher education-related tax benefits included in the Internal Revenue Code. The six largest are detailed below. They are: (1) the Hope Scholarship Credit; (2) Lifetime Learning Credit; (3) the Tuition and Fee Deduction; (4) the Student Loan Interest Deduction; (5) Coverdell Education Savings Accounts; and (6) Qualified Tuition Program (529 Plans).
Other federal higher education tax benefits include: (7) the tax-free status of scholarships, fellowships, grants, and tuition discounts for degree candidates; (8) the tax-free value of student loan cancellations; (9) the education exception to taxation on early withdrawals from individual retirement accounts; (10) the Education Savings Bond Program (if savings bonds are cashed in for education expenses, the bond is not included in taxable income); (11) the tax-free value of employer-provided education assistance; and finally (12) the business deduction for work-related education expenses. 
Tax Credits
Two of the largest higher education tax benefits are the Lifetime Learning Credit and Hope Scholarship Credit. Created in the Taxpayer Relief Act of 1997, individuals enrolled in post-secondary education can select one of the two credits to decrease their tax bill. Families or spouses can claim the credit if the relevant student qualifies as their dependent.
The Lifetime Learning Credit is available for up to $2,000 annually (20% of the first $10,000 spent on higher education) for an unlimited number of years. Qualified students only have to be enrolled in at least one post-secondary course and do not have to be pursuing a degree. The maximum Hope Scholarship Credit is $1,650 (100% of the first $1,100 spent on higher education; 50% of the next $1,100) and can only be claimed for the first two years of post-secondary, degree-seeking education. However, that amount can be claimed for each qualified individual, as opposed to the per-family Lifetime Credit, making the Hope Scholarship Credit more valuable for families with multiple students enrolled in college.
Both credits have inflation-adjusted income ceilings of $55,000 ($110,000 for joint filers) and are phased out as income approaches that ceiling. Qualified education expenses include tuition and related fees required by an institution for enrollment. Other related expenses, such as room and board, transportation, and insurance and medical expenses, cannot be claimed as qualified education expenses for the purposes of these credits. The Lifetime Learning Credit will provide taxpayers with an estimated $2.2 billion in tax reductions in 2007, and the Hope Scholarship Credit will provide $3.3 billion.
Tax Deductions
A higher education tuition and fees tax deduction is available to individuals who do not use the Lifetime Learning or Hope Credit. Unlike a tax credit, which reduces the amount of taxes owed, the tuition and fees deduction reduces taxable income.
The maximum tuition and fees deduction is $4,000 and varies according to income level. But the income ceiling is approximately $25,000 higher for the tuition and fees tax deduction than for the Hope Scholarship and Lifetime Learning tax credits, making the deduction more popular for higher-income families. The tuition and fees deduction also cannot cover personal expenses such as room and board. It is estimated that the deduction will reduce taxes by $1.5 billion for all eligible taxpayers in 2007.
Individuals can also deduct the interest paid on a federal or private student loan from their taxable income. The maximum student loan interest deduction is $2,500 and decreases as income levels increase. The income ceiling for the loan interest deduction is $15,000 lower than the tuition and fees deduction. In 2007, the policy will reduce taxes for all student loan borrowers by an estimated $810 million.
Tax-Free Savings Accounts
The federal government also gives tax breaks to families or individuals that save money for the higher education costs of their children or other designated beneficiaries. The Coverdell Education Savings Account (ESA), formerly known as an Education IRA, is an investment trust account specifically designated for qualified education costs, which include both K-12 expenses and higher education expenses such as tuition and fees, books, and room and board for students enrolled at least part-time. Money deposited and interest earned on that money are not taxed, and withdrawals for education expenses are tax-free. Only individuals with income below $110,000 ($220,000 for joint filers) can contribute to a Coverdell ESA, and annual contributions are limited to a total of $2,000 per beneficiary. In aggregate, the policy will lower taxes for participants by $10 million in 2007.
Qualified tuition programs, also known as "529 plans," are savings plans established by states and institutions of higher education. A 529 plan allows families or individuals to prepay for a student’s qualified education expenses—tuition and fees, books, and room and board for students enrolled at least part-time—or contribute to a tax-free account specifically designated for these higher education expenses. Institutions can only sponsor prepaid plans. An estimated $830 million in tax reductions will be provided through the benefit in 2007.
There are two types of savings plans: direct, state-administered and broker-administered. Every state now has at least one 529 plan available, and the state-administered plans usually offer better deals and benefits than brokers, who generally charge extensive fees for account management. In addition, seven states offer matching grants to low-income families who contribute to state plans. Contribution limits vary by state, and in general states allow for between $200,000 and $300,000 in tax-free savings. There are no income restrictions for contributors, and each contributor can add up to $60,000 in tax-free funds over a five year period per beneficiary.
