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You've been laid off from your job for the third time or you are a mid-career professional who wants to make a career change. You believe that more education will lead to a better job or improved career options, but expense is a major barrier. The IRS grants several higher education benefits that both employees and self-employed workers may use to enhance their skills or even earn a degree. These benefits may be deductions or credits, each of which allows you to reduce your federal tax obligation for education costs for a new line of work. You may combine some tax breaks but not others, and specific benefit amounts and income limits change each year. Consult with a tax professional to determine which deductions or credits provide the maximum benefit for you.
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IRS Work-Related Education Allowances
To qualify for IRS deductions for work-related education, taxpayers must be self-employed or working for an employer. If you work for an employer, you must itemize your expenses on Schedule A along with filing form 1040 or 1040NR. If you are self-employed, you must file Schedule C, Schedule C-EZ, or Schedule F along with form 1040. In addition, your education must be a requirement to maintain your present job, salary or status, or improve your skills in your present job. Qualifying education may be refresher courses or vocational training. You may even earn a degree that includes coursework not directly related to your present position. However, the IRS may disallow a deduction for work-related education if it is required to meet the minimum education requirements for your job or if your program of study immediately qualifies you for a new line of employment.
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IRS Education-Related Tax Deductions
Even if your educational program does not qualify for a work-related education deduction, you may still qualify for education-related deductions from the IRS that reduce your taxable income. Taxpayers may apply these deductions for programs of their choice, including qualified education costs to train for a new career. The IRS defines qualified educational expenses as tuition and fees, room and board, books and related supplies, and other necessary expenses such as transportation to and from classes.
The Tuition and Fees deduction reduces your taxable income by up to $4,000 for 2010 tax returns. Taxpayers need not itemize to take advantage of the deduction. However, taxpayers who file as married filing separately, who can be claimed as a dependent on another taxpayer's return, nonresident aliens, and taxpayers whose 2010 income exceeds $80,000 for single taxpayers or $160,000 for married taxpayers filing jointly are not eligible for this deduction.
Taxpayers whose 2010 incomes fall below $70,000 for single taxpayers and $140,000 for married taxpayers filing jointly may deduct payments for student loans - including interest - by filing Schedule A with form 1040. The loans may be federally-guaranteed loans or loans from private lenders but must have been taken specifically to cover qualified educational expenses.
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IRS Education Tax Credits
The IRS has two education-related tax credits that apply for 2010 income tax returns: the Lifetime Learning Credit and the American Opportunity Credit. These credits reduce the taxpayer's income tax obligation and do not require taxpayers to itemize their deductions to qualify. Taxpayers may apply these credits to qualified education costs for a new line of work, however, the IRS forbids taxpayers to claim both credits in a single tax year.
The American Opportunity Credit, which modifies the Hope Credit and makes it more widely available, was created under the American Recovery and Reinvestment Act (ARRA), commonly known as the stimulus plan. Unlike Hope Credits, which applied only to the first two years of an undergraduate program, American Opportunity Credits apply to up to four years of post-secondary enrollment.
For 2010 tax returns, single taxpayers earning up to $80,000 and married taxpayers filing jointly earning up to $160,000 qualify for the full credit. The credit covers 100 percent of the first $2,000 of qualifying expenses and 25 percent of the next $2,000 of qualifying expenses for students enrolled at least half-time in a degree-granting program.
The Lifetime Learning Credit provides a credit of up to $2,000 per year for qualified educational expenses with no limit to the number of years a taxpayer may claim the credit. Taxpayers may use Lifetime Learning Credits to pursue both undergraduate and graduate education. Students may also apply the credit for a single class and need not pursue a degree to qualify.
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Tax-Exempt Education Savings
Taxpayers may also make tax-exempt contributions to a 529 savings plan to cover eligible expenses, including education costs for new employment. Unlike Coverdell Education Savings Accounts, which have upper age and income limits as well as annual contribution limits, 529 savings plans are available to taxpayers of all ages and income brackets with no limits on annual contributions. Distributions from 529 savings plans used for tuition, fees, books, and supplies that are required for undergraduate or graduate programs in the United States and selected foreign institutions are tax-free. Room and board and off-campus living expenses are also eligible for tax-free distribution. Some states even allow residents to deduct contributions to 529 savings plans from state income taxes. Check with your state's tax laws regarding contributions to 529 savings plans.
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- Bill Bischoff. The Last Word on the New Tax Bill; in Smart Money; retrieved at http://www.smartmoney.com/personal-finance/taxes/the-last-word-on-the-new-tax-bill-1292961330431/
- IRS.gov: American Opportunity Credit -- Questions and Answers; at http://www.irs.gov/newsroom/article/0,,id=211309,00.html
- IRS.gov: Publication 970 -- Tax Benefits for Education; at http://www.irs.gov/pub/irs-pdf/p970.pdf
- IRS.gov: Tax Benefits for Education -- Information Center; at http://www.irs.gov/newsroom/article/0,,id=213044,00.html
- Kay Bell. Tax Credits Help with Higher Education Costs; at Bankrate.com; retrieved at http://www.bankrate.com/brm/itax/tips/20010116a.asp
- Quicken: How to Choose Between Tax-Free College Savings Accounts; at http://quicken.intuit.com/personal-finance-tips/financial-planning/How-to-Choose-Between-Tax-Free-College-Savings-Accounts.html
- SavingforCollege.com: Understanding 529 plans; at http://www.savingforcollege.com/college_savings_101/
- TurboTax: Deduction for Higher Education; at http://turbotax.intuit.com/tax-tools/tax-tips/College/Deduction-for-Higher-Education/INF12002.html
- Flickr. familymwr. Army Expands Youth Career Guide Program to All Garrisons; from familymwr's photstream.
- Flickr. Paul Lowry. Mortarboard and Tassel; from Paul Lowry's photostream.