There are numerous tax breaks for you if you're planning to go to college, if you're already in college, or if you've graduated and you're paying back loans on your education.

Education IRAs

Taxpayers may withdraw funds from an IRA, without penalty, for their own higher education expenses or those of their spouse, child, or even grandchild. Usually, if you withdraw funds from an IRA before you're 59-1/2, you must pay an additional 10% tax on the withdrawal amount. This 10% tax is waived for that amount of the withdrawal that is used for the qualified expenses of the student.

In addition, for each child under age 18, families may deposit $500 per year into an education IRA in the child's name. Earnings in the education IRA will accumulate tax-free and no taxes will be due upon withdrawal if the money is used to pay for post-secondary tuition and required fees (less grants, scholarships, and other tax-free educational assistance), books, equipment, and eligible room and board expenses. Once the child reaches age 30, his or her education IRA must be closed or transferred to a younger member of the family.

A taxpayer's ability to contribute to an education IRA is phased out when the taxpayer is a joint filer with an adjusted gross income between $150,000 and $160,000, or a single filer with an adjusted gross income between $95,000 and $110,000. There are a few restrictions. For example, a student who receives a tax-free distribution from an education IRA may not benefit from the Hope or Lifetime Learning education tax credits in the same year.

Federal Tax Credits 

A tax credit is better than a deduction. A credit is subtracted directly from your federal income tax on a dollar-for-dollar basis. This saves you more money than a deduction, which you subtract from your income before you calculate your tax and which yields much less than dollar-for-dollar savings. Federal tax credits are a resource for those paying out-of-pocket qualified tuition payments.

If someone claims the student as a dependent for tax purposes, that person, not the student, may receive the tax credit, even if the student files a tax return. Otherwise, only the student may receive the credit. 

The Hope Scholarship Credit offers up to a $1,500 annual tax credit for tuition and fees for each student enrolled at least part-time in the first two years of postsecondary education. The education tax credit cannot be used for room and board, books, equipment, or activities.

The Lifetime Learning Credit applies to college juniors, seniors, and graduate students. It allows taxpayers supporting a college student to claim a tax credit equal to 20 percent of the first $5,000 of tuition and fees, not to exceed $1,000 per family. Both credits are phased out at adjusted gross income (AGI) of $40,000 (single filers) or $80,000 (joint filers) and are eliminated at AGI of $50,000 (single filers) and $100,000 (joint filers).

Nondeductible contributions of $500 per year can be made to an Education IRA for children to age 18. The money grows tax deferred and any withdrawals not more than the amount of qualified education expenses for that tax year are not subject to federal taxes. The money must be withdrawn before the beneficiary turns 30 years of age or may be transferred to a younger child. Couples can make a contribution on behalf of the child provided their adjusted gross income does not exceed $150,000 on a jointly filed return.

Student Loan Interest Reduction

For many college graduates, one of their first financial obligations is to repay their student loans. The student loan interest deduction will reduce the burden of the repayment obligation by allowing students or their families to take a tax deduction for interest paid in the first 60 months of repayment on student loans. The deduction is available even if an individual does not itemize other deductions.

The maximum deduction is $1,000 for 1998, $1,500 for 1999, $2,000 in 2000, and $2,500 in 2001 and beyond. It is phased out for joint filers with adjusted gross income between $60,000 and $75,000, and single filers with adjusted gross income between $40,000 and $55,000. The deduction is available for all loans taken out solely to pay for qualified higher education expenses for you, your spouse, or a person who was your dependent when you took out the loan. It does not matter when you took out the loan, as long as it is still in the first 60 months of repayment. After that, you may not claim an interest deduction for payments on that loan.

Community Service Loan Forgiveness

This provision excludes from income student loan amounts forgiven by non-profit, tax-exempt charitable or educational institutions for borrowers who take community-service jobs that address unmet community needs. For example, a recent graduate who takes a low-paying job in a rural school will not owe any additional income tax if in recognition of this service her college or another charity forgives a loan it made to her to help pay her college costs. This provision applies to loans forgiven after August 5, 1997.