Income Tax Code for Tuition Income: Credits, 529 Plans, and Loans

The Internal Revenue Code handles tuition money through several different sections, and which one applies depends on whether you are paying tuition, receiving a scholarship, getting help from your employer, saving in a 529, paying off student loans, or having a loan forgiven. The main provisions to know are Section 25A (education credits), Section 117 (scholarships and tuition reductions), Section 127 (employer educational assistance), Section 529 (tuition savings plans), Section 221 (student loan interest), Section 108 (discharged debt), and Section 6050S (how schools report tuition on Form 1098-T). The rules below walk through each situation and where they intersect.

Credits When You Pay Tuition

Section 25A gives you two credits to choose from, and you cannot use both for the same student or the same expenses in the same year.

The American Opportunity Tax Credit is worth up to $2,500 per eligible student. It equals 100 percent of the first $2,000 in qualified tuition and related expenses plus 25 percent of the next $2,000.¹ Forty percent of it is refundable, so up to $1,000 can come back to you even if you owe no tax.² The AOTC only covers the first four years of postsecondary education, the student must be enrolled at least half-time in a degree or credential program, and a felony drug conviction disqualifies the student.

The Lifetime Learning Credit is broader but smaller. It equals 20 percent of up to $10,000 in qualified expenses, capped at $2,000 per return rather than per student.¹ No year limit, no half-time requirement, and graduate courses qualify. A single class taken to sharpen your professional skills fits here.

Both credits phase out at the same income levels. The credit shrinks once modified adjusted gross income passes $80,000 ($160,000 joint) and disappears above $90,000 ($180,000 joint).³ Starting in 2026, anyone claiming either credit needs a Social Security number valid for employment, issued before the return’s due date. If a parent claims the credit, the student needs a qualifying SSN too.²

Scholarships and Fellowships

Section 117 keeps scholarship and fellowship money out of your gross income, but only if you are a degree candidate at an eligible school and only to the extent you spend it on qualified expenses: tuition, enrollment fees, and required books, supplies, and equipment.⁴ Any portion used for room, board, or travel is taxable, even if the award nominally covers those costs.

If a grant requires you to work in exchange for the money, such as teaching undergraduates or running a lab, the payment is compensation and taxed as wages. A fellowship that just supports your studies is tax-free up to the cost of tuition and required materials; a stipend tied to specific duties is not.

Coordinating a Scholarship With an Education Credit

Scholarships reduce the tuition expenses you can count toward the AOTC or Lifetime Learning Credit. A student with a $6,000 Pell Grant and $8,000 in tuition has only $2,000 left in qualified expenses for credit purposes, capping the AOTC at $2,000 instead of $2,500.

You have a choice, though. Federal rules let you treat part of a Pell Grant or other scholarship as covering living expenses rather than tuition. That portion becomes taxable income, but it frees up more qualified tuition for the credit calculation.⁵ For a low-income student with little or no tax liability, the refundable piece of the AOTC often outweighs the tax on the reclassified scholarship. Publication 970 and the Form 8863 instructions walk through the math.

Tuition Reductions for University Employees and Graduate Assistants

Section 117(d) handles a different situation. If you work at an eligible educational institution, tuition reductions provided to you, your spouse, or your dependents for undergraduate study are excluded from gross income, and the benefit cannot favor highly compensated employees. Graduate students engaged in teaching or research for the school get a parallel rule: their graduate-level tuition reductions are also tax-free.⁴ Without this provision, a TA with a $30,000 tuition waiver would owe tax on that amount as compensation.

Employer Educational Assistance

Under Section 127, your employer can pay up to $5,250 per year toward your education without that money counting as taxable income. Qualifying expenses include tuition, fees, books, supplies, and equipment. The employer needs a written educational assistance plan that does not disproportionately benefit highly compensated employees.⁶ The $5,250 cap has been flat for years, but for tax years after 2026 it will be adjusted for inflation.⁷ Anything above $5,250 gets added to your taxable wages on your W-2 and is subject to normal withholding and payroll taxes.

If a program does not qualify under Section 127, tuition help may still escape taxation as a working condition fringe benefit under Section 132, but only when the education relates directly to your current job duties rather than a future career.⁸ A nurse funded for training in a new clinical technique fits; the same nurse pursuing an MBA likely does not qualify under Section 132, though the first $5,250 can still ride under Section 127.

Saving for Tuition Through a 529 Plan

Section 529 creates qualified tuition programs, better known as 529 plans. Contributions go in with after-tax dollars, earnings grow tax-free, and distributions come out untaxed when used for qualified higher education expenses: tuition, fees, books, supplies, room and board for students enrolled at least half-time, and computer equipment.⁹

Withdrawals used for anything else trigger income tax on the earnings portion plus a 10 percent additional tax on those earnings.¹⁰ Your original contributions are not penalized. The 10 percent add-on is waived up to the amount of a scholarship the beneficiary receives, though income tax on the earnings still applies.

Since 2024, unused 529 funds can be rolled into a Roth IRA in the beneficiary’s name. Conditions apply: the 529 account must have been open at least 15 years, contributions from the last five years are not eligible, each year’s rollover cannot exceed the annual Roth contribution limit, and the lifetime cap is $35,000 per beneficiary.

One coordination trap: you cannot claim an education credit on the same expenses paid with tax-free 529 money.¹¹ Families often pay at least $4,000 of tuition out of pocket to preserve the full AOTC, then apply 529 funds to remaining costs like room and board.

Student Loan Interest

Section 221 lets you deduct up to $2,500 in interest paid on qualified education loans each year, as an above-the-line deduction, so you get it whether or not you itemize. You cannot take the deduction if someone else claims you as a dependent, and married filers must file jointly.¹²

The deduction phases out at higher incomes, and the base statutory thresholds are adjusted annually for inflation. For tax year 2025, the range was $85,000 to $100,000 for single filers and $170,000 to $200,000 for joint filers.² Check the IRS site or Publication 970 for the current-year figures.

When Forgiven Student Loans Count as Income

The rule here changed in 2026. The American Rescue Plan Act had temporarily excluded all discharged student loan debt from gross income, and that provision expired on December 31, 2025. For borrowers whose loans are forgiven through income-driven repayment plans in 2026 or later, the forgiven balance generally counts as taxable income unless they qualify for the IRS insolvency exclusion.

Two categories of discharge are permanently tax-free. Public Service Loan Forgiveness is excluded under Section 108(f)(1) and was never dependent on the temporary provision. Discharge due to the borrower’s death or total and permanent disability is excluded under Section 108(f)(5).¹³ If you are on an income-driven plan expecting forgiveness years out, plan for the tax hit or check whether insolvency at discharge might offset it.

How Your School Reports Tuition: Form 1098-T

Section 6050S requires colleges, universities, and vocational schools participating in federal student aid programs to report tuition transactions to the IRS on Form 1098-T.¹⁴ The form carries your name, address, and taxpayer identification number along with the numbers that drive your credit calculation.¹⁵

Two boxes matter most:

Box 1: payments the school received for qualified tuition and related expenses during the year.
Box 5: scholarships or grants the school administered and applied to your account.

The gap between the two shapes your education credit. If Box 5 is larger than Box 1, the excess may be taxable under Section 117. Check the figures against your own records, because school accounting systems can lag payment timing or misallocate aid between semesters. Schools must send your copy by January 31, and errors are corrected under the procedures in the general instructions for information returns.¹⁵ If you spot a mistake, contact the financial office before filing.

Nonresident alien students are handled differently. When a scholarship exceeds tuition and mandatory fees, the school reports the excess and any withholding on Form 1042-S rather than 1098-T. U.S. citizens and residents for tax purposes are not subject to that withholding.

1
Office of the Law Revision Counsel. 26 USC 25A – American Opportunity and Lifetime Learning Credits
2
Internal Revenue Service. Publication 970, Tax Benefits for Education
3
Internal Revenue Service. American Opportunity Tax Credit
4
Office of the Law Revision Counsel. 26 USC 117 – Qualified Scholarships
5
U.S. Department of the Treasury. Interaction of Pell Grants and Tax Credits
6
Office of the Law Revision Counsel. 26 USC 127 – Educational Assistance Programs
7
Internal Revenue Service. Revenue Procedure 2025-32
8
Internal Revenue Service. Publication 5137 – Fringe Benefit Guide
9
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
10
Office of the Law Revision Counsel. 26 USC 530 – Coverdell Education Savings Accounts
11
Internal Revenue Service. Education Credits: AOTC and LLC
12
Office of the Law Revision Counsel. 26 USC 221 – Interest on Education Loans
13
Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
14
Office of the Law Revision Counsel. 26 US Code 6050S – Returns Relating to Higher Education Tuition and Related Expenses
15
Internal Revenue Service. Instructions for Forms 1098-E and 1098-T