Education Tax Credits and Savings in 2026

Federal law offers two education credits, a student loan interest deduction, an employer assistance exclusion, and 529 savings plans that the One Big Beautiful Bill Act substantially expanded.

California offers none of the credits, and — most consequentially — does not conform to the 529 rules for K-12 education. A withdrawal that is entirely tax-free on your federal return can generate California income tax on the earnings plus a 2.5% state penalty. Families funding private school through a 529 are frequently unaware of this until the California return is prepared.

We advise families and employers in Temecula, Murrieta, San Diego, Riverside, and San Bernardino.

The American Opportunity Tax Credit

Up to $2,500 per student — 100% of the first $2,000 of qualified expenses plus 25% of the next $2,000. 40% is refundable, up to $1,000, making it valuable even to families owing no tax.

Requirements: the student must be pursuing a degree or recognized credential, enrolled at least half-time for at least one academic period, in the first four years of postsecondary education, and free of a felony drug conviction. The credit may be claimed a maximum of four tax years per student.

Qualified expenses are tuition, required fees, and course materials — including books and equipment required for enrollment, whether or not purchased from the institution. Room and board do not qualify.

Phaseout runs from $80,000 to $90,000 of modified AGI for single filers, and $160,000 to $180,000 for joint filers. These thresholds are not inflation-indexed.

The Lifetime Learning Credit

Up to $2,000 per return — 20% of the first $10,000 of qualified expenses. Note “per return,” not per student: a family with three students in college claims one $2,000 maximum.

Its advantages are breadth. There is no degree requirement, no half-time enrollment requirement, no four-year limit, and no felony drug restriction. It covers graduate study, professional courses, and single classes taken to acquire job skills — which makes it the credit for career changers, part-time students, and continuing professional education.

It is entirely nonrefundable, and it covers only tuition and required fees, not course materials.

You cannot claim both credits for the same student in the same year. For an undergraduate in their first four years, the AOTC is almost always better — larger, partly refundable, and per-student rather than per-return.

529 Plans After OBBBA

OBBBA meaningfully broadened 529 plans at the federal level:

• K-12 withdrawal limit doubled from $10,000 to $20,000 per beneficiary annually, beginning with tax year 2026
• Expanded K-12 expenses effective July 5, 2025 — beyond tuition to curriculum materials and textbooks, tutoring by an unrelated qualified tutor, standardized test fees including SAT and ACT, dual-enrollment fees, and educational therapies for students with disabilities from licensed providers
• Postsecondary credentialing — tuition, fees, books, supplies, equipment, and testing or continuing education fees for recognized credential programs, including registered apprenticeships and state-licensed certifications
• 529-to-ABLE rollovers made permanent

The credentialing expansion turns the 529 from a college account into a career-training account, useful for adult learners and for beneficiaries who never attend a four-year school.

Separately, and predating OBBBA, SECURE 2.0 permits rolling unused 529 balances into a Roth IRA for the same beneficiary, subject to a lifetime cap, a 15-year account age requirement, and the annual Roth contribution limit.

The California Problem

OBBBA changed federal law only. California does not conform to the 529 provisions for elementary and secondary education, nor to the increased distribution limit.

For a California family, a 529 withdrawal used for K-12 expenses is treated as a non-qualified distribution: the earnings portion is subject to California income tax, plus California’s additional 2.5% penalty on the earnings.

California also treats a 529-to-Roth IRA rollover as a taxable distribution for state purposes, with the same 2.5% penalty exposure — another divergence with real cost.

Two further points for California residents: the state offers no deduction or credit for 529 contributions, unlike most states with an income tax, and qualified higher education withdrawals remain tax-free for California purposes. The divergence is specific to K-12 use and Roth rollovers, not to 529 plans generally.

Other Education Tax Benefits

Student loan interest deduction — up to $2,500 of interest, available without itemizing, subject to income phaseouts.

Employer educational assistance under Section 127 — up to $5,250 per employee annually, excluded from income. OBBBA made permanent the inclusion of employer payments toward student loans within that limit and indexed the amount for inflation. For employers in competitive hiring markets, this is one of the more efficient benefits available: deductible to the employer, excluded from the employee’s income, and exempt from payroll tax on both sides.

Coverdell ESAs and the exclusion for scholarships and fellowship grants covering tuition and required fees remain available.

Student loan forgiveness is a separate matter with changed treatment as of January 1, 2026 — see student loan tax issues.

Coordinating the Benefits

The same dollar of expense cannot support two benefits. Tuition paid with a tax-free 529 distribution cannot also generate an AOTC claim.

The usual planning move is to pay a portion of tuition from other funds — enough to claim the $2,500 AOTC — and use 529 funds for the remainder. Because the AOTC is worth more per dollar than the tax-free growth on an equivalent 529 withdrawal, sequencing matters and is easy to get wrong when the bursar is paid directly from the plan.

Note also that the credits are claimed by whoever claims the student as a dependent, and that Form 1098-T from the institution frequently reports amounts that do not match what was actually paid in the year — a common source of correspondence audits.

Form 1098-T and Why It Causes Problems

Educational institutions report tuition on Form 1098-T, and the IRS matches credit claims against it. The form is also a frequent source of mismatch, because what the institution reports and what the family actually paid in the calendar year often differ.

The recurring causes: institutions report amounts billed or paid on their own schedule, spring semester charges are commonly billed in December and paid in January, scholarships and grants reported in Box 5 reduce qualified expenses but may relate to a different term, and course materials purchased elsewhere — which qualify for the American Opportunity Tax Credit — never appear on the form at all.

The result is that a correct claim can look wrong to the matching system. The defense is the family’s own records: bursar account statements showing payment dates, receipts for required books and equipment, and documentation of how scholarships were applied.

One planning point follows from this. A scholarship that is not restricted to tuition can sometimes be treated as taxable income to the student — who typically has little or no tax liability — which frees up qualified expenses to support a parent’s credit claim. Where a student has significant scholarship funding, that allocation is worth calculating rather than defaulting.

Frequently Asked Questions

Can I claim both education credits?

Not for the same student in the same year. You may claim the AOTC for one student and the Lifetime Learning Credit for another on the same return.

Does California offer education tax credits?

No equivalent to the AOTC or Lifetime Learning Credit. California has a separate College Access Tax Credit for contributions to a state scholarship fund, which is a different benefit entirely.

Will a 529 withdrawal for private school tuition be taxed in California?

Yes. California does not conform to the federal K-12 provisions, so the earnings portion is taxable for California purposes plus a 2.5% state penalty, even though the withdrawal is tax-free federally.

How much can I withdraw from a 529 for K-12 in 2026?

Up to $20,000 per beneficiary federally, doubled from $10,000. California does not follow this limit and treats such withdrawals as non-qualified.

Can 529 funds pay for a trade certification?

Yes, federally. Qualified postsecondary credentialing expenses now include tuition, fees, books, supplies, equipment, and testing or continuing education fees for recognized credential programs and registered apprenticeships.

Can my employer pay my student loans tax-free?

Yes, within the $5,250 annual Section 127 limit, made permanent and inflation-indexed by OBBBA.

Who claims the credit — parent or student?

Whoever claims the student as a dependent. If the student is not claimed as a dependent, the student may claim it, though a dependent student generally cannot claim the refundable portion of the AOTC.

Can grandparents pay tuition without gift tax consequences?

Yes. Tuition paid directly to the institution is excluded from gift tax entirely under the qualified transfer rule, with no dollar limit and without consuming the annual exclusion or lifetime exemption. Payments made to the student instead of the school do not qualify, which makes the mechanics matter as much as the intent.

What if my child receives a scholarship after I claimed a credit?

A scholarship received in a later year that relates to expenses already used for a credit can require recapture of part of that credit. Where the timing is uncertain, it is worth tracking which expenses supported which claim.

Plan the Sequence Before Tuition Is Paid

Most education tax planning is about ordering — which dollars come from the 529, which support a credit, and whether a K-12 withdrawal is worth the California cost. Those decisions are made when the bill is paid, and they cannot be undone at filing.

Pietro Canestrelli holds an LL.M. in Taxation and advises families and employers on education tax planning, 529 structuring, and credit examinations. Schedule a consultation, or review our tax credits overview.