How to Allocate Education Expenses to Credit and Savings Bonds

by Mark Kennan

The IRS offers several income tax breaks for higher education expenses. If you use savings bonds to pay for the costs, you may have to decide between savings bond interest exclusion and an education credit when you file your taxes, if you don’t have enough expenses to claim both. Determining whether to use your education expenses to exclude savings bond interest or to claim an education credit depends on your tax bracket and which education credit you are eligible to claim.

Qualified Educational Expenses

To exclude savings bond interest from income or to claim an education credit, you must have qualifying educational expenses. Such expenses include tuition and fees — but not room and board — at a college, university or trade school. The American Opportunity Credit also includes expenses for books and other required supplies, even if you do not have to purchase them through the university. However, if you have any tax-free assistance, such as scholarships, you must reduce your qualifying expenses by the amount of the tax-free assistance you receive.

Using Two Tax Breaks

You can claim only one education tax credit in a given year, but you can use the savings bond interest exclusion and claim an education tax credit in the same year as long as you have enough expenses. Each dollar of expenses can only be used in connection with one tax break. For example, assume you have $5,000 of savings bond interest and $5,000 of qualified educational expenses. If you exclude the $5,000 of savings bond interest, you do not have any qualified educational expenses remaining to claim an education credit.

Education Credit Savings

The savings from claiming an education credit depends on which credit you’re eligible to claim. The American Opportunity Credit, which is available only for qualifying undergraduate students, equals 100 percent of your first $2,000 of qualifying expenses and 25 percent of the next $2,000. The Lifetime Learning Credit is available for both graduate and undergraduate costs, but it is less advantageous than the American Opportunity Credit. If you claim the Lifetime Learning Credit, you can claim 20 percent of up to $10,000 of expenses.

Benefits of Claiming the Savings Bond Interest Exclusion

The higher your tax bracket, the more valuable is the interest exclusion on your taxes. For example, if you are in the 35 percent bracket, $5,000 of savings bond interest would cost you $1,750 in income taxes if you didn’t exclude it. If you only pay tax at the 10 percent rate, it costs you only $500 in taxes. When comparing, look at which tax break saves you more. For example, if you fall in the 10 percent tax bracket, either tax credit is more beneficial because you save at least 20 percent. However, if you’re in the 35 percent bracket and can only claim the Lifetime Learning Credit, the savings bond interest exclusion is likely to save you more.

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