Education expenses can reduce taxes in one of three ways. First, job-related education expenses can be deducted, along with other miscellaneous itemized deductions, to the extent they exceed 2% of the adjusted gross income. Education expenses are deductible if they are: job related, do not qualify a person for a new business, and are not taken to meet the minimum educational standards for qualification in a person’s business. The costs of obtaining an undergraduate degree do not qualify because they are usually meeting the minimum educational standards. The costs of obtaining a graduate degree, especially in business, generally qualify if a job is in the same subject area as the classes unless the degree qualifies that person for a new business, such as law or medicine. Examples of some of the costs that can be deducted include tuition, books, supplies, car expenses, and travel costs.
Second, job-related education expenses can be excluded as a working condition fringe benefit. Many employers used this approach when the educational assistance provisions temporarily expired in prior years.
Third, education expenses under an employer’s educational assistance program can be excluded. This is generally the best approach. Check to see if the employer offers an educational assistance plan. If the employer does, up to $5,250 from income can be excluded. Although meals, lodging, and transportation costs cannot be reimbursed, the costs that can be reimbursed tax-free include: tuition, books, supplies and equipment.
An employer can either pay the expenses directly to the school or reimburse the taxpayer after they are paid. Proof of the expenses will need to be provided, such as receipts for tuition and books.
Unlike the deduction for education expenses, the subjects being studied do not have to be business or job related. Thus, a college degree can be completed or non-business courses can be taken. However, subjects considered a sport, game, or hobby are ineligible unless required as part of a degree program or related to an employer’s business. Graduate courses are also included in this exclusion.
Savings include both income tax and Social Security tax. Additionally, many states do not tax educational assistance reimbursements, thus saving even more.
A person has $45,000 in income, is in the 25% tax rate bracket, and has $5,500 of educational expenses. If that person claims the expenses as a deduction, they will save:
Education expenses $5,500
2% floor ($45,000 x 2%) ($900)
Deductible education expenses 4,600
Income tax rate 25%
Tax savings $1,150
If a person’s employer reimburses $5,250 of their educational expenses under an educational assistance plan, the following will be saved:
Federal income tax savings
at 25% tax bracket $1,313
Social Security taxes at 7.65% for 2013 402
Total savings $1,715
The unreimbursed education expenses of $250 ($5,500 - 5,250) are considered a miscellaneous itemized deduction subject to the 2% floor. The person receives no additional tax savings since 2% of the adjusted gross income of $900 ($45,000 x 2%) exceeds the $250.
The person saves $565 ($1,715 - 1,150) in tax by using their employer’s educational assistance plan.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.
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