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How the IRS can help you pay your tuition

College financial aid advisers seldom mention one of the most common sources of funding: the IRS. Tax breaks get little credit for reducing the cost of college, yet a recent study found they can be worth more than traditional sources of financial aid such as federal grants and work-study programs.

According to the November 2011 report by the National Center of Education Statistics (NCES), tax breaks accounted for about 6 percent of all undergraduate financial aid in 2007-2008, benefiting mostly middle-class families. Federal work-study programs represent 1 percent of undergraduate aid dollars, and federal grant programs other than the Pell Grant program are 3 percent, the NCES study said.

The IRS gives college students a break

The NCES study found that 47 percent of all undergraduate college students received an education tax benefit in 2007-2008. The total value of this financial support amounted to $6.85 billion, according to estimates from the College Board.

The report looked at two main forms of tax benefits--tax deductions, which reduce the amount of income a family has to pay federal taxes on, and tax credits, which are subtracted from the amount of tax a family owes. Because tax deductions have more value for higher-income families, who generally pay taxes at higher rates, the report also found that tax benefits, unlike some other forms of financial aid, tend to benefit middle-income students the most.

How much can tax benefits save you?

For families who qualify, tax breaks can be a significant source of savings. The NCES study found that students who received tax benefits saw an average of $700 in savings. By comparison, those same students received an average of $400 in federal grant funding and veterans benefits. They also received an average of $1,300 in non-federal grants.

The primary beneficiaries of federal tax breaks were middle-class families, reports the NCES. Among the families of dependent undergraduates, 63 percent classified as high-middle-income, or families making between $66,600 and $104,599, received tax benefits. For low-middle-income families, with incomes ranging from $36,100 to $66,599, that number was 56 percent.

By contrast, less than one-third (29 percent) of families with incomes below $36,100 received tax benefits. Many low-income families didn't qualify for tax breaks because their grant aid and veterans benefits covered their tuition, making them ineligible for the benefits. Just under half (48 percent) of high-income students received tax benefits; most who did not qualify had incomes that exceeded the maximum of $57,000 for single filers.

Income matters when it comes to the value of tax benefits as well. The report found that middle-income families received average tax benefits ranging from $900 to $1000, while low-income families received average benefits of $600. Low-income students reported significantly higher federal grant aid than any other income group.

Tax benefits for college students (and their parents)

Your financial aid entitlement may not end with your college financial aid package. If grants and other aid don't cover your college expenses, you may be eligible for a tax credit or deduction. Available tax benefits for college students and their parents include:

  • American Opportunity and Lifetime Learning Tax Credits. An extension of the Hope Credit, the American Opportunity Credit of 2011-2012 provides an annual credit of up to $2,500 per eligible full-time student. The Lifetime Learning Tax Credit allows a credit of up to $2,000 for any student taking one or more courses. Income restrictions apply for both tax credits.
  • Tuition and fees deduction. You can reduce your taxable income and by extension, your tax burden, by deducting qualified education expenses for yourself or a dependent student. The maximum amount of the deduction is $4,000. Like the tax credit, higher-income filers do not qualify (Your modified adjusted gross income must be below $80,000 to claim the deduction).

These tax credits and deductions help current college students reduce the financial impact of college expenses. For additional information on education tax benefits, including eligibility and rules on combining tax benefits, refer to the IRS.

Although they don't reduce your upfront tuition and fees, tax credits and deductions can have a significant impact on your total college cost. Don't forget to take advantage of this important benefit this April 15.