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.

Hope and Lifetime Learning Credits

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 2007, you can claim a Hope Scholarship credit of up to $1,650 if your student is in his or her first or second year of college and your income doesn't exceed $94,000 if you are married filing a joint return ($47,000 for individuals.) The credit is based on 100% of the first $1,100 of qualifying college expenses and 50% of the next $1,100. 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 $4,950 of credits. No matter how many students qualify for the Lifetime Learning credit—which can be as much as $2,000, based on 20% of up to $10,000 of qualifying higher-education expenses—the same income limits apply to the Lifetime Learning Credit as to the Hope Credit.

Dependency Rules

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 forgo the dependency exemption and let your student file his or her own tax return and claim the education credit. This rule even applies if your income is so high that you lose the right to claim part of the personal exemptions for each of your family members.

Tuition Deduction

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.

Tapping tax-free college savings

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.

Tax-free Savings Bond Interest

Interest earned on EE or 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 $98,400 ($65,600 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.

Updated for tax year 2007