Tax Reform Education Changes and How It Impacts Your Tax Return
Editor’s Note: This article was originally published on December 27, 2017 and updated in 2020 for relevancy.
The Tax Cuts and Jobs Act (TCJA) modified and eliminated a few benefits for people who are saving for college and people who are paying off their student loans. However, tax reform left popular education tax benefits unchanged (such as the credits and the student loan interest deduction).
Education tax benefits available are different depending on whether the taxpayer is currently attending college, have student loan payments, or are saving for college. This article discusses education tax reform changes.
To help you find the areas that are relevant to you, we’ve grouped the information in three sections below:
- Education and Tax Reform for Students in College
- Education Tax Deductions and Benefits for People With Student Loans
- Tax Benefits for People Saving for Education
Education & Tax Reform for Students in College
Tax reform didn’t change popular education tax credits, such as the American Opportunity Credit and the Lifetime Learning Credit.
Due to the Bipartisan Budget Act and the Taxpayer Certainty and Disaster Tax Relief Act of 2019, the tuition and fees deduction was extended. Read on to learn about other tax benefits.
American Opportunity Credit Stayed the Same
The TCJA didn’t change the American Opportunity Credit (AOC).
The AOC is a credit of up to $2,500 per eligible student. Up to $1,000 of the credit is refundable. It’s only available for four tax years per student and if a student hasn’t completed the first four years of postsecondary education before the end of the tax year. Eligible students must be enrolled at least half-time for at least one academic period and must be pursuing a program leading to a degree or other recognized credential.
The AOC is generally claimed by the parents of undergraduate students. Students may need to work together with their parents to determine the amount of eligible expenses to claim the credit and make sure their parents have copies of Form 1098-T, receipts for expenses and the account transcript.
Form 8863 together with Form 1040 or 1040-SR; tuition and fees reported on Form 1098-T.
Lifetime Learning Credit Stays the Same
Tax reform didn’t change the lifetime learning credit.
The lifetime learning credit is a credit of up to $2,000 for qualified education expenses paid for all eligible students included on the taxpayer’s tax return. There is no limit on the number of years the lifetime learning credit can be claimed, and the student does not have to enroll in a minimum number of hours to claim the credit.
The lifetime learning credit is generally claimed by graduate students, by undergraduate students enrolled less than half-time, and by students who work full-time and take a class or two to develop skills or finish a degree. Because the lifetime learning credit is smaller than the AOC, students who qualify for both credits choose the AOC.
Form 8863 together with Form 1040 or 1040-SR; tuition and fees reported on Form 1098-T.
Nontaxable Scholarship and Grant Rules Stay the Same
The TCJA does not make changes to the rules for scholarships, fellowships and grants.
Under current law, scholarships required to be used for tuition and fees remain nontaxable when applied to tuition and fees. Scholarships that can be used to pay any expense (such as room and board) are nontaxable when spent on qualified expenses and taxable when spent on nonqualified expenses. For this purpose, qualified expenses include;
- Tuition and fees required to enroll at or attend an eligible educational institution, and
- Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in the course of instruction.
Qualified education expenses do not include the cost of:
- Room and board
- Clerical help
- Equipment and other expenses that aren’t required for enrollment in or attendance at an eligible educational institution
Taxpayers who receive benefits through a qualified tuition reduction program can also treat their benefits as nontaxable. These programs are often offered by colleges to their employees and benefits may be extended to the spouses and dependents of employees. These programs are generally for undergraduate work.
Many students in grad school who are teaching and research assistants also receive tuition reductions. A tuition reduction (or tuition waiver) for grad school can be nontaxable if the waiver is provided by an eligible institution and the grad student performs teaching or research activities for the institution.
In any other cases, scholarships or grants provided in exchange for services are taxable.
Tax law prevents taxpayers from double dipping on education benefits. That means an individual can’t claim the AOC or lifetime learning credit for expenses paid with a nontaxable scholarship. However, sometimes a taxpayer benefits by treating a nontaxable scholarship income as taxable and claiming the AOC. This is most likely to be beneficial if the student has very little other income and the student’s parents can claim a full AOC.
Scholarship information may be reported on Form 1098-T or Form 1042-S; taxable scholarships are reported on Form 1040.
Tuition and Fees Deduction Has Been Extended
As part of the Bipartisan Budget Act of 2018 and the Taxpayer Certainty and Disaster Tax Relief Act of 2019, the tuition and fees deduction has been made available through 2020.
The tuition and fees deduction allows taxpayers to reduce their Adjusted Gross Income (AGI) by up to $4,000.
The tuition and fees deduction is generally claimed by the same people who claimed the lifetime learning credit. However, the tuition and fees deduction has phase-outs at higher points than the lifetime learning credit, so it could be claimed by some people who did not qualify to claim the lifetime learning credit because their income was too high.
Form 8917 together with Form 1040 or Form 1040-SR; tuition and fees reported on Form 1098-T.
Education Exception to Early Distribution Penalty for IRAs Stays the Same
The TCJA didn’t make changes to the IRA penalty exception for education. In some circumstances, taxpayers may take a distribution from an IRA before reaching age 59½ and not have to pay the 10% additional tax on early withdrawals. The exception to the 10% additional tax applies if, for the year of the distribution, the taxpayer pays qualified education expenses for:
- The taxpayer
- The taxpayer’s spouse
- The taxpayer or spouse’s child, foster child, adopted child, or descendant of any of them
Distributions from traditional IRAs are generally fully taxable in the year the distribution is made. That’s because taxpayers often do not have any basis in their traditional IRA and the entire distribution is taxable. Taxpayers with some basis in an IRA may have a partly taxable distribution. Distributions from Roth IRAs are generally not subject to income tax.
IRA distributions reported on Form 1099-R; penalty exceptions claimed on Form 5329.
Education Savings Bond Exclusion Stays the Same
The TCJA did not make changes to savings bonds for education. Taxpayers who cash in certain savings bonds under an education savings bond program are allowed to exclude the interest from income.
Taxpayers who want to use this provision need to plan ahead to use the exclusion.
Interest reported on Form 1099-INT; exclusion reported on Form 8815 together with Schedule B and Form 1040 or 1040-SR.
Exclusion for Employer-Provided Education Assistance Stays the Same
The TCJA didn’t make changes to employer-provided education assistance benefits. The employer-provided education assistance exclusion allows employers to offer up to $5,250 per year in educational assistance as a tax-free benefit.
Employees who receive this type of assistance work with their human resources to make sure they meet the program requirements and can receive nontaxable benefits. Information about these benefits may be reported in Box 14 of Form W-2. Taxable benefits are sometimes paid out (for example, if an employer pays more than the allowable yearly limit, the excess is taxable). The value of any taxable benefits is reported in Box 1 of Form W-2 along with other types of compensation. Some forms of education could also potentially be considered a working condition fringe benefit; these types of benefits are usually excludable as well.
Taxable assistance reported in Box 1 of Form W-2
Business Deduction for Work-Related Education Eliminated for Employees
The TCJA eliminated the ability for employees to deduct work-related expenses as an itemized deduction on Schedule A. All types of unreimbursed employee business expenses aren’t allowed any more. This applies to work-related education expenses as well as other expenses such as uniforms, membership in professional organizations, and other ordinary and necessary employee business expenses. Self-employed taxpayers may continue to deduct qualifying education expenses on Schedule C.
Taxpayers enrolled at least half time in the first four years of undergraduate school may be able to claim the AOC instead. Taxpayers enrolled less than half time may be able to claim the lifetime learning credit.
Schedule A filed with Form 1040 or 1040-SR; Schedule C filed with Form 1040
Education Tax Deductions and Benefits for People With Student Loans
Tax reform hasn’t changed these education provisions: the Student Loan Deduction and Student Loan Repayment Assistance. Only the Exclusion for Student Loan Cancellation has been modified.
Student Loan Interest Deduction Stays the Same
The TCJA did not make changes to the student loan interest deduction.
The student loan interest deduction allows taxpayers to reduce their taxable income by up to $2,500. It is based on the amount of qualified student loan interest paid during the year. That’s interest paid on a loan taken out solely to pay for qualified education expenses for a qualified student. One key requirement is that the student must be the taxpayer, spouse or dependent, and enrolled at least half time in a program leading to a degree, certificate, or other recognized credential at an eligible institution.
The student loan deduction is claimed by people making student loan payments. It has an income-based phase-out, and a small percentage of people do not qualify for the deduction because of the phase-out. Taxpayers who refinance their student loans generally may continue to claim the deduction.
Student loan interest is reported on Form 1098-E and deducted on Form 1040, Form 1040-SR, or 1040NR.
Student Loan Repayment Assistance Remains
Tax reform left in place rules that allow certain student loan repayment assistance made on behalf of taxpayers to be tax-free in some circumstances.
Loan repayment assistance is nontaxable if received for any of the following:
- The National Health Service Corps (NHSC) Loan Repayment Program (NHSC Loan Repayment Program).
- A state education loan repayment program eligible for funds under the Public Health Service Act.
- Any other state loan repayment or loan forgiveness program that is intended to provide for the increased availability of health services in underserved or health professional shortage areas (as determined by such state).
Exclusion for Student Loan Cancellations Modification
The TCJA modified the exclusion for cancelled student loans.
Income from the cancellation of debt is generally subject to tax. However, there are a limited number of exceptions taxpayers can use to exclude cancelled debts from income. Certain qualifying students can still exclude cancellation of student loan debt from income.
To qualify, the loan must have a provision that states that part of the debt will be canceled if the student works:
- For a certain period of time,
- In certain professions, and
- For any of a broad class of employers.
The TCJA also added a new provision that student loan debt forgiveness due to death or permanent and total disability is excludable from income.
When a debt is cancelled it sure doesn’t feel like income. But under tax law, it’s considered a taxable event. Taxpayers with cancelled debt often don’t have a lot of cash flow to pay tax on the income. That’s why the possibility of claiming an exclusion makes a big difference.
Cancellation of debt is reported on Form 1099-C. Most exclusions are reported on Form 982.
Tax Benefits for People Saving for Education
The primary tax reform education news is this: 529 plans may now be used for more than just college!
529 Plans Expanded
The TCJA expanded the types of expenses a 529 plan can be used to pay.
Contributions to a 529 plan (also called qualified tuition programs, or QTPs) aren’t deductible on the federal return, but amounts deposited in the plan can grow tax free until distributed. When distributions from a 529 plan during the year are less than the beneficiary’s qualified education expenses, distributions are also tax-free.
The usage of 529 plans include:
- K-12 elementary and secondary school tuition for public, private, and religious schools. Previously, only Coverdell ESA funds could be used for primary and secondary expenses.
Taxpayers will also be able to rollover amounts from 529 plans into ABLE accounts.
Some states provide a state tax benefit for contributing to the state 529 plan.
Distributions from 529 plans are reported on Form 1099-Q.
Coverdell Education Savings Accounts Remain the Same
The TCJA doesn’t change the rules for Coverdell Education Savings Accounts (Coverdell ESAs).
Contributions to a Coverdell ESA aren’t deductible, but amounts deposited in the account can grow tax free until distributed. There is a $2,000 annual contribution limit, and the ability to contribute is phased-out when income exceeds the phase-out limit.
When distributions from a Coverdell ESA during the year are less than the beneficiary’s qualified education expenses, distributions are also tax-free. Distributions can be used for elementary, secondary, and higher education expenses.
Taxpayers can continue to contribute funds to their Coverdell ESAs or start a new Coverdell ESA.
Contributions to Coverdell ESAs are reported on Form 5498-ESA; distributions from Coverdell ESAs are reported on Form 1099-Q.
More Help With Education & Tax Reform
Because tax reform changed the tax benefits for education, taxpayers should update their tax strategies. Knowing which education tax benefits are now available helps taxpayers make an informed decision.
If you have questions about how the tax changes apply or will apply to your college plans, make an appointment with a tax professional.
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