Education Tax Benefits (continued)

The regulations also clarify that only the person legally obligated to repay the education loan may take the interest deduction. If someone else makes payments on a student's education loans, the student gets to take the deduction, not the other individual. For example, if a grandparent helps the student out with a few loan payments, the student takes the deduction, not the grandparent. These payments are treated as though they were first paid to the student, and then by the student to the lender.

Note that the borrower must have been legally obligated to make payments under the terms of the loan. This means that if the borrower voluntarily makes payments of interest during a period when such payments are not required, such as during a forbearance, deferment or grace period, that interest is not deductible. However, if the interest is required as part of the forbearance or deferment agreement, then the interest is deductible.

A qualified education loan is defined as a debt borrowed solely to pay higher education expenses. Mixed-use loans do not qualify. This means that if the borrower refinances their education loans and receives cash out, interest on the new loan is no longer deductible. However, if the excess cash is only used to pay for higher education expenses, the interest on the new loan remains deductible.

Interest on private education loans qualifies, provided that the higher education expenses are attributable to a particular academic period and the disbursement used to pay for those expenses occured during the academic period or a 90-day window at the start and end of the academic period. Education loans do not need to be federally guaranteed to qualify. The debt, however, may not be owed to anybody who is related to the borrower.

Employer Education Assistance

Your employer may provide you with up to $5,250 in employer education assistance benefits for undergraduate or graduate courses tax-free each year. The benefits must have been paid for tuition, fees, books, supplies, and equipment. Travel, lodging and meals are not included. Courses involving sports, games or hobbies are not included, unless they are required as part of a degree program or are related to the business of your employer.

Payments above $5,250 may also be tax-free, if they represent a working condition fringe benefit. This means that if you had paid for the expenses, you would have been able to deduct them as an employee business expense.

Tuition and Fees Deduction (2002-2007)

This tax benefit is also known as the Limited Deduction for Tuition Expenses or as the Torricelli Deduction.

Starting in 2002, taxpayers can deduct up to $3,000 in tuition expenses as an exclusion from income. This means you can deduct the tuition expenses even if you don't itemize deductions on schedule A of your 1040. The deduction increased to $4,000 in 2004 through 2007 and ends in 2007. The deduction is phased out for taxpayers with adjusted gross incomes of $65,000 to $80,000 (single filers) and $130,000 to $160,000 (married filing jointly). Within the phaseout income bands the amount of the deduction is reduced to $2,000. You cannot use this deduction if you claimed a tax credit for education expenses for the same student in the same year. You can use it in conjunction with tax-free distributions from Coverdell Education Savings Accounts, qualified tuition programs, and education savings bonds, provided that different education expenses form the basis for each benefit. You cannot take the deduction and use the Hope Scholarship or Lifetime Learning tax credit for the same student in the same year. If you are claimed as a dependent on someone else's tax return, you cannot use the tuition deduction. The tax deduction is only for tuition expenses paid by you. The deduction is only available for taxpayers who file IRS Form 1040.