Take advantage of tuition tax credits and deductions.
Parents who qualify should take advantage of two federal tax credits for tuition costs. The American Opportunity Tax Credit and Lifetime Learning Credit are almost as good as getting money outright, since they are a dollar-for-dollar reduction of the tax you owe. And you can use these credits against tuition payments that you make using student loans.
To qualify for these credits, your adjusted gross income must be less than $80,000 if you're single or less than $160,000 if you're married and filing a joint return.
The American Opportunity Tax Credit lets you slash your taxes by up to $2,500 a year per child for qualified tuition and fees paid during the first four years of college — 100% of the first $2,000 in tuition, and 25% of the next $2,000. That means you need to have at least $4,000 in tuition expenses to get the full credit.
The Lifetime Learning Credit lets you slash your taxes by up to $2,000, regardless of how many children you have in college at one time ($4,000 for students in Midwestern disaster areas). You can take 20% of the first $10,000 in qualified tuition and fees but you can't claim it in the same year that you take the American Opportunity Credit for the same student. There is no limit on the number of years the Lifetime Learning credit can be claimed for each student.
The education toward which you're applying a federal credit must occur within the tax year in which tuition was paid, or within the first three months of the following year. Since academic years aren't the same as calendar or tax years, you need to be careful how you claim a credit on your tax return.
If your income qualifies you to take the American Opportunity Tax Credit and Lifetime credits as well as the new deduction, you may only take one of them for the same child in the same year. Remember, a deduction reduces your taxable income by a percent of every dollar, whereas a credit offers dollar-for-dollar reduction of the tax you owe. If you're in the 25% tax bracket, a $100 deduction means you'll pay $25 less in taxes, whereas a $100 credit means you'll pay $100 less.