Every Friday evening, my husband’s college friends have a Zoom happy hour: it’s practicing social distancing and being social at the same time. The conversations have been dominated, of late, by the COVID-19 pandemic and how it’s affecting our families. One popular gripe? College tuition and room and board.

During the pandemic, students are being sent home from college, and some classes are being canceled. That means students are left with semesters cut short or a move to online courses, leaving unused or barely touched housing and meal plans. Schools are dealing with this in different ways. Some are offering partial tuition and fee refunds, while others are choosing to keep fees intact, suggesting that the underlying expenses (like administration and the costs of paying faculty) haven’t really changed.

According to Inside Higher Ed, 90% of parents with children already enrolled in college say they are not “comfortable” with the current landscape. That number ticks up a little – to 93% – for parents of students attending private institutions. Of those, 47% expect a “meaningful reduction in price.”

Mark Kantrowitz, publisher of SavingForCollege.com, reports that about 70% of colleges are offering refunds. The refunds are typically 40%-60% of the room and board cost for the spring semester.

For those parents who are fortunate enough to get a partial refund of tuition and fees, there are some potential tax traps. Let’s start with the obvious: tax deductions and credits.

  • The tuition and fees deduction was extended to cover qualified education expenses paid in 2018, 2019, and 2020. The tuition and fees deduction is based on qualified education expenses used to pay for yourself, your spouse, or your dependents. It’s an above-the-line deduction, which means that you can claim the deduction even if you don’t itemize. For the 2019 tax year, the deduction is allowed for qualified education expenses paid in 2019 for an academic period beginning in 2019 or in the first 3 months of 2020. You only can claim a tuition and fees deduction for qualified education expenses not refunded when a student withdraws.
  • The Lifetime Learning Credit (LLC) offers up to $2,000 for qualified education expenses paid for all eligible students per return. In other words, the LLC is limited by return, not by student. Like the tuition and fees deduction, the LLC is based on qualified education expenses you pay for yourself, your spouse, or your dependents. Similarly, the credit is allowed for qualified education expenses paid in 2019 for an academic period beginning in 2019 or in the first 3 months of 2020. For example, if you paid $1,500 in December 2019 for qualified tuition for the spring 2020 semester beginning in January 2020, you may be able to use that $1,500 in figuring your 2019 credit. You can claim the LLC for qualified education expenses not refunded when a student withdraws.
  • The American Opportunity Credit (AOC) offers up to $2,500 for each qualifying student on your federal income tax return. Unlike the LLC, that means you can claim the AOC for each qualifying student on your federal income tax return. It’s also partially refundable. Like LLC, the AOC is based on qualified education expenses you pay for yourself, your spouse, or your dependents. The credit is allowed for qualified education expenses paid in 2019 for an academic period beginning in 2019 or in the first 3 months of 2020. And as before, you can claim the AOC for qualified education expenses not refunded when a student withdraws.

According to the Internal Revenue Service (IRS), a refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year.

  • If you receive a refund after 2019 of qualified education expenses paid on behalf of a student in 2019 and the refund is paid before you file an income tax return for 2019 (remember, Tax Day has been moved to July 15), the amount of qualified education expenses for 2019 is reduced by the amount of the refund.
  • If you receive a refund after 2019 of qualified education expenses paid on behalf of a student in 2019 and the refund is paid after you file an income tax return for 2019, you may need to repay some or all of the credit.
  • But if you pay qualified education expenses in both 2019 and 2020 for an academic period that begins in the first 3 months of 2020 and you receive a refund, you may choose to reduce your qualified education expenses for 2020 instead of reducing your expenses for 2019.

You should also pay attention to the source of the funds. If you’re paying as you go from already-taxed funds, or from loans, there’s typically no tax impact to you when you receive a refund. But if you receive a refund of funds that you originally paid out of a tax-favored account, there may be tax consequences.

If you return money from a 529 college savings account to the account – for the same student – it remains tax-free. Generally, the money has to be put back within 60 days of the refund (that’s the result of the PATH Act). But the IRS made clear in Notice 2020-23 that if the 60 day period ends between April 1, 2020, and July 15, 2020, you can stretch the return of the contribution to July 15, 2020. 

The College Savings Foundation warns that refunds of money that originated from a 529 plan could be subject to federal and state taxes and penalties if it remains outside of the plan and is not used for qualified educational expenses. If you don’t return the funds to the account, they could be considered non-qualified distributions and subject to tax and a 10% tax penalty. But if you’re headed back to school this year, you may want to hold onto the money: check with your financial advisor or a tax professional for more info.

There’s additional tax relief for families who qualify for grants and other free money. Students who receive emergency financial aid grants under the Coronavirus Aid, Relief, and Economic Security Act (or CARES Act) qualify for tax-free treatment under section 139 of the Tax Code. And you already know that some students may be eligible for the Economic Impact Payments (EIP), or stimulus checks: those are tax-free, too.

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Kelly Erb is a tax attorney, tax writer and podcaster.

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