Most of us don’t have the full four years of college expenses socked away in a 529 plan when our student starts college. That means that most of us use a combination of savings, out-of-pocket spending, and borrowing to pay for college.
It’s logical to assume that you should use up all of your savings before spending out of pocket or borrowing, but that’s not entirely true. If your income is below $180,000 (married filing joint), then you are eligible for tax credits for qualified higher education expenses (QHEEs), but you can only take them for expenses that weren’t paid with another education tax benefit such as a 529 plan account.
Depending on a variety of factors, either the American Opportunity Credit (up to $2,500) or the Lifetime Learning Credit (up to $2,000) could be a fit for your family. The AOTC is 100% of the first $2,000 in expenses and 25% of the next $2,000, per student (multiple students = multiple tax credits). To qualify for the maximum AOTC, you need to spend $4,000 out of pocket each year. The LLC is 20% of the first $10,000 in expenses paid for all eligible students, so to receive the maximum credit, you need to spend $10,000 out of pocket.
Details on the AOTC and LLC are available here. Note that only a parent claiming the student as a dependent on their tax return can take the credit. And again, the IRS does not allow “double-dipping” on education tax benefits, so expenses paid out of 529 account distributions are not eligible for these tax credits. So if you’re eligible for a credit but have been using your 529 plan to pay for expenses all year, don’t distribute any more for 2015.