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A common scholarship myth is that millions of dollars go unclaimed each year, and it is exactly that: a myth. But there’s another way to save money that has gone untapped by thousands of students and their families, a source of help “hidden” in plain sight. It’s so hidden, students failed to take advantage of millions of dollars in benefits, according to a recent government study. What is this hidden financial gem?

The tax break.

Study: Families Drop the Ball on Tax Benefits

A report (.pdf) filed by the Government Accountability Office (GAO) found “27 percent of eligible tax filers did not claim either the tuition deduction or a tax credit.” The report, in the news when the GAO delivered testimony (.pdf) in a December 2006 U.S. Senate hearing, also says, “Tax filers failed to reduce their tax liability by $169, on average, and 10 percent of these filers could have reduced their tax liability by over $500.” That’s a lot of money to leave on the table.

Why did 27% of all eligible tax filers decide to forgo a chance to save on their education? While the report does not provide a specific reason, it speculates “the apparently suboptimal use of postsecondary tax preferences may arise, in part, from the complexity of using these provisions.” Translation: Figuring out the tax code is really hard.

What’s maddening is the information on how to take advantage of these benefits is relatively easy to find. The IRS has all the information about education-related tax benefits (.pdf), but who has time to read 82 pages of tax code? A quick primer follows below, but we recommend speaking with a tax professional for more personalized assistance.

The Benefits in a Nutshell

When it comes to education-related tax breaks, there are two kinds of benefits: the tax credit and the tax deduction. Note that you may not claim both a credit and a deduction—you must choose one path or the other.

Tax credits:

• Reduces the amount of taxes you pay dollar-for-dollar, no matter what tax bracket you’re in (though the amount of the credit you qualify for could depend on your income). Typically, you can save more money with a credit than a deduction. Note that you won’t receive a refund if the amount of your credit exceeds your total tax liability.
• Example: If you owe $3,000 in taxes and receive a $2,000 tax credit, it means that you will pay $2,000 less in taxes.

The two main types of tax credits for education offered by the IRS are the:

• Hope Tax Credit: Provides a $1,650 tax credit per student per year for college expenses for the first two years of school.
• Lifetime Learning Credit: Provides a credit equal to 20% of the first $10,000 paid in qualified expenses per year. This credit may be claimed for an unlimited number of years.

Read FastWeb’s Tuition Tax Credits to find out how to take advantage of these benefits.

Tax deduction:

• Reduces the amount of money on which you will be taxed. The lower your tax bracket, the more money you can save (by percentage).
• Example: If you owe $3,000 in taxes and claim a $2,000 tax deduction, you save a percentage of the $2,000 (not the full $2,000, as you would with a credit). The amount you save will depend on your tax bracket. If you’re in the 10% tax bracket, in our example you would save $200.

(Disclaimer: All figures are examples and not indicative of actual tax rates.)

The deduction to claim on educational expenses is the Limited Deduction for Tuition Expenses (read FastWeb’s Tax Deductions: Tuition and Fees for more information). Because the law that allows this deduction was passed after IRS paper forms had been published, take special care when filling out your 1040 (.pdf) this year.

Still Confused?

The GAO report estimated nearly 50 percent of paid tax preparers failed to take full advantage of all possible tax breaks. While your tax professional might suggest one of the credits or deductions, you may want to offer a friendly reminder to leave no stone unturned when it comes to sniffing out possible educational tax breaks. Also review FinAid’s Education Tax Benefits page, a wealth of information on this topic. The IRS also offers telephone assistance at: 1-800-829-1040.

Tax breaks are a lot less glamorous than scholarships and grants—no one is going to hand you an oversized check with your name on it. But it would be a mistake to dismiss them because they’re complicated. Tax benefits are out there, waiting for you to use them. Fight the intimidation factor and use the resource links in this article to sniff them out. Your time and effort may result in saving hundreds of dollars.

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