Most 4-year college programs extend over 5 tax years, which can help you maximize the tax credits available to you. One thing to remember is that you can only claim the American Opportunity Credit four times, meaning it will only be available for the first 4 years, and then the Lifetime Learning Credit is available.
To learn more about these credits, see Tax Credits for Higher Education.
Note: Instead of the American Opportunity Credit, you may claim the Lifetime Learning Credit in the student’s first 4 years of college, if it would yield a greater tax benefit. The choice of the American Opportunity Credit or Lifetime Learning Credit depends on how much tuition was paid for the year.
The American Opportunity and Lifetime Learning Credits have income phaseouts. If you can’t take one of the credits because of the income limits, you might want to let your child take the credit. Before you decide to do this, there are a few things to consider. Most education credits are not refundable meaning that you do not get a benefit from them unless you have a tax liability. However, the American Opportunity credit is up to 40% refundable meaning that a dependent who claims the credit may receive some benefit from the credit even if they do not have a tax liability. It’s important to note, too, that if you’re eligible to claim your child as a dependent but choose not to do so, your child can’t claim a personal exemption on their individual return.
If you have money left in a Coverdell ESA after a child graduates or reaches age 30, the beneficiary of the ESA may be changed to another family member or rolled over into an existing account of another family member. The change of beneficiary and rollover will be tax-free if the family member is under age 30 and you complete the transaction within 60 days. The age limitation doesn’t apply, however, if the new beneficiary is a special-needs beneficiary. Also, for each Coverdell ESA that you have, you can roll over money only once in a 12-month period. If you do not comply with these requirements a 10% penalty will apply to the withdrawal. To learn more about ESAs, see Coverdell Education Savings Accounts.
If you plan on contributing to a Coverdell ESA, you must make your contribution by the time your tax return is due (usually April 15). You should make your contribution as early as possible, though, to take advantage of the account’s tax-free earnings.
Just think, you can pay educational expenses with tax-free ESA earnings and also be eligible for one of the other educational tax benefits, such as the American Opportunity or Lifetime Learning credit. Of course, you can’t claim both tax breaks for the same expenses.
For more information, see Publication 970: Tax Benefits for Education.