Tax Prep Dispatch: Tuition and Fees Deduction Review

Oh no, they didn’t!

Oh yes, they did!

At the end of 2019, when training was finalized, forms had been updated and software was about to roll out, Congress passed extender legislation. Not only did it change tax law applicable to tax year 2019, much of it also changed the tax law for tax year 2018. Oh boy.

Of all the revived and updated tax law, the tuition and fees deduction is probably the one most frequently encountered at VITA sites—and also one of the more complex. Although most taxpayers with education expenses should probably take one of the credits instead of the tuition and fees deduction, the preparer has to understand the tuition and fees deduction to make the proper determination. Add the fact that the tuition and fees deduction has not been a relevant issue for two years, and it would seem that we all could use a review.

OVERVIEW

The tuition and fees deduction is covered in the Extender section of Publication 4012, Volunteer Resource Guide. But it really doesn’t address all the twists and turns.

First, here’s the gist of what you need to know.

The IRS calls it the tuition and fees deduction, but it is actually an adjustment to income. It appears on line 21 of Schedule 1, Additional Income and Adjustments to Income. A taxpayer does not have to itemize deductions to claim this benefit.
The adjustment is basically an alternative to education credits. A taxpayer’s tuition and fee expenses can be used to claim either an education credit or the tuition and fees deduction—not both for the same student. The taxpayer can choose.
Like education credits, a taxpayer does not qualify for the tuition and fees deduction if the taxpayer is using the married filing separately filing status.
Qualifying expenses includes tuition and fees—not books.
The adjustment is claimed on Form 8917, Tuition and Fees Deduction.
The tuition and fees deduction is also now available for tax year 2018.
The taxpayer is required to have a Form 1098-T, Tuition Statement. And, just like education credits, the information on the form 1098-T may not be sufficient and the preparer probably needs to see the student’s account transcript to determine actual qualified education expenses.

WHEN TO CLAIM TUITION AND FEES DEDUCTION

The education tax credit issue is already challenging. Adding the tuition and fees deduction makes it just a bit trickier because it is difficult to predict what is better for the taxpayer: an education credit or the tuition and fees deduction.

Here are some guidelines:

If the taxpayer qualifies for the American Opportunity Credit (AOC), that will almost always provide a better outcome than the tuition and fees deduction. That’s mainly because for most taxpayers, part of the AOC is refundable.
In some cases, the effects on the state income tax return must be considered. For some states, a reduction to federal AGI means a decreased state income tax liability. If this applies to your state, remember to review the effects on the state return.
If the taxpayer does not qualify for the AOC (part-time students, graduate students), but can claim the lifetime learning credit, it can be difficult to predict which provides more benefit. It’s better to just try it both ways.

Try it both ways? What does that even mean?

Prepare the return claiming the lifetime learning credit.
Note the outcome – amount of refund or balance due for both federal and state returns.
Remove the lifetime learning credit.
Prepare the return claiming the tuition and fees deduction.
Compare the new outcome to the result using the lifetime learning credit.

EXAMPLES

Example 1

Dan, age 28, lived in Chicago all of 2019. He was a single, part-time graduate student and he cannot be claimed as a dependent. His total income was $11,800 in wages. He paid the following out-of-pocket education expenses:

Tuition and fees: $1,200
Textbooks purchased from Amazon: $650

Dan remembers that his parents used to get a nice education credit when he was an undergrad and he wants to know if he can get that on his 2019 return. He asked when he had his 2018 taxes done last year and they said, “No.” Now he wants to double check.

So, what to do about Dan? Since he is a part-time student and already has a degree, he doesn’t qualify for the AOC. His standard deduction is $12,200, which wipes out his taxable income. Therefore, the Lifetime Learning Credit won’t do him any good. Since he has no taxable income, an adjustment won’t help him either—at least, not on his federal return. But Illinois income tax is based on federal AGI. By claiming the tuition and fees deduction on his federal return, he reduces his AGI by $1,200. This decreases his Illinois income tax by $75.

Dan saves money on his state return by claiming the tuition and fees deduction on his federal return. If his situation was similar for tax year 2018, he might benefit from amending his 2018 federal and state returns to claim the tuition and fees deduction on his federal return.

Example 2

Now let’s look at Dan’s twin sister, Natalie. Her situation is the same as Dan’s, except her wage income was $16,000. Since her income is more than the standard deduction, the preparer needs to try it both ways.

TUITION & FEES LIFETIME LEARNING

Income $16,000 $16,000

Tuition and fees deduction $1,200 $0

AGI $14,800 $16,000

Taxable income $2,600 $3,800

Tax $261 $383

Lifetime Learning Credit $0 $240

Net federal income tax $261 $143

IL state income tax $620 $679

Total tax $881 $822

Natalie pays less tax overall using the lifetime learning credit, but it’s close. If Natalie was a graduate student in 2018, the preparer should look at her 2018 return to see if she might benefit from filing amended state and federal returns to claim the tuition and fees deduction on the federal return to save money on her state return.

RESOURCES

For more detailed information, refer to Publication 970, Tax Benefits for Education. The January 17, 2020 revision includes the extender legislation. Also, the Legislative Extender section of Publication 4491-X, VITA/TCE Training Supplement, includes additional information about the tuition and fees deduction.

Want to know more about extender legislation? See the VITA Train Caboose - Tax Extenders.