Personal Finance: Ask the Experts

Get advice on money matters from The Bee's Claudia Buck and a panel of local experts

November 9, 2012
Which education tax break is best?

Q: We have about $6K in a 529 for our daughter's college expenses. Now that she is a freshman, we have incurred a few expenses: $1,200 laptop, $700 payment and books. My question is this: Is it better to withdraw the funds from our 529, or use the education credit on our federal tax return? I know I can't use both and I'm not clear about the education credit options. Reading the IRS site, it appears you can't use the American
Opportunity for room and board. She did receive the CSU Cal grant of approx. $3K per semester, a $1,000 Pell Grant, and a $1,000 scholarship. I don't want to make a withdrawal from the 529 until I'm sure that I'm unable to use the credit.


A: There is no simple answer to questions regarding which education incentive is best to use because there are so many variables involved. The IRS publication explaining the Tax Benefits for Education, Publication 970, is 87 pages long!

The following comments are intended to be general guidance. You should talk to your tax advisor regarding your specific situation.

In general, the American Opportunity Credit is the most favorable, as 40% of the credit is refundable. That means that if your deductions and other nonrefundable credits reduce your tax to zero, you will get back the refundable portion of the credit.

The maximum credit is $2,500 per student, of which up to $1,000 can be refunded to you. There is an income limit. If you are filing a joint income tax return with your spouse, your income has to be below $180,000 ($90,000 if you are single or head of household). You cannot claim the credit if you are married filing a separate return, regardless of income level.

Expenses that qualify for the credit include tuition and certain expenses paid to an eligible educational institution (college, university, vocational school or other post-secondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education). Expenses for books, supplies and equipment needed for a course of study are included in qualified education expenses. Room and board are not.

Qualifying education expense must be reduced by tax-free educational assistance, such as scholarships, grants or assistance provided by an employer. The American Opportunity Credit is only available for the first 4 years of postsecondary education. See page 10 of Publication 970 for a flowchart that you can use to determine whether you qualify for the American Opportunity Credit, as there are other requirements.

If your income is over the above mentioned limit or if your expenditures include room and board, it may be better to use funds from a 529 account. The earnings portion of the funds withdrawn to pay for qualified educational expenses of the designated beneficiary of the account, including room and board, are not taxable. There is no income limit affecting this tax break.

You can claim and American Opportunity Credit and take tax free distributions from a 529 plan in the same year to the extent that expenses qualifying for 529 distributions do not qualify for the American Opportunity Credit. So you can pay qualifying room and board expenses from 529 distributions and claim the American Opportunity Credit for qualifying tuition and fee expenses.

There is also a Lifetime Learning Credit. You cannot claim the American Opportunity Credit and the Lifetime Learning credit for the same eligible student in the same tax year. The Lifetime Learning Credit is limited to $2,000 per year and is nonrefundable. The income limits are lower: $122,000 married filing joint, $61,000 single/head of household. Married taxpayers filing separate returns do not qualify for this credit. It is available for an unlimited number of years. Qualifying expenses are similar to the American Opportunity Credit.

Most tax preparation software has an education tax break maximization feature. Once the raw data is input, the software will determine which education tax incentive is the best. The choice of incentive may change from year to year depending on your specific circumstances.

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Meet Our Financial Experts

Claudia Buck

Claudia Buck is The Sacramento Bee's personal finance columnist. Read all her columns here. Contact her at

Terri Carpenter

Terri Carpenter offers advice on job hunting, retraining and career counseling. Carpenter works at Sacramento Works Inc., the career and job training arm of the Sacramento Employment and Training Agency (SETA). With 15 years in the field, she has hands-on experience with everyone from first-time job seekers to career professionals seeking advice after a layoff or looking for a mid-career change. Ask her a question.

Carlena Tapella

Carlena Tapella is a partner in the law firm of Webb & Tapella Law Corp. in Sacramento. The firm specializes in estate planning and probate, such as estates, trusts, conservatorships and litigation. She is a past president of the Sacramento County Bar Association's Estate Planning & Probate Section. Ask her a question.

Kimberly Foss

Kimberly Foss, certified financial planner, is the founder of Empyrion Wealth Management in Roseville. With nearly 30 years in the financial industry, her clients include women in transition, small business owners, retirees and "pre-retirees." Ask her a question.

Jesse Weller

Gregory Burke, a CPA and tax expert with John Waddell & Co. in Sacramento since 1984, worked as an IRS tax auditor for six years. He’s a past chairman of the California Society of CPAs. Ask him a question.

Daniel Tahara

Daniel Tahara takes your questions about California taxes. Tahara, a spokesman for the state Franchise Tax Board, has 10 years of experience as a tax auditor. Ask him a question.

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