The American Opportunity Tax Credit (AOTC) allows a maximum $2,500 per child per year for those paying for an undergraduate tuition. This credit can only be used for qualifying expenses that are not being paid with a 529 distribution. The Lifetime Learning Credit offers a maximum credit of up to $2,000. The Lifetime Learning Credit is not restricted to undergraduate study and can be used in graduate programs as well.
Child tax credit payments began over the summer and will continue through the year for qualifying families. When you go to file your 2021 taxes, you will only be eligible for half of the normal child care credit because the other half was already received throughout the second half of 2021. Since the deduction is based off of your 2020 income, a significant increase in your income may leave you owing some of the money back to the IRS if it exceeds the thresholds set.
A 529 is a great way to save for education expenses. Withdrawals are tax-free when used on qualified education expenses. However, if the money is withdrawn for non-qualified expenses or if there is money left over to be withdrawn after all expenses are paid this is considered taxable income. In addition to paying taxes on the leftover amount, you will also incur a 10% penalty for these withdrawals.