Education Tax Credits
There are 3 educational tax credits that can offset the expenses of higher education: the American Opportunity credit, the Hope Scholarship credit, and the Lifetime Learning credit. However, for any given student in a given year, only one of these credits can be used. The credits are calculated on Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits). The American Opportunity credit applies to expenses for the first 4 years of postsecondary education, with a maximum of $2,500 per student, of which 40% is refundable, meaning that 40%, or $1,000, of the credit can be used to offset payroll tax liability and can even be refunded to the taxpayer.
The Lifetime Learning credit may be used to offset the expense of higher education beyond the 4th year of postsecondary education and also for nondegree courses for acquiring or improving job skills. The maximum credit is $2,000 per year for any given taxpayer, and can only be used to offset tuition, fees, or expenses that are required by the educational institution.
Education Tax Credit Rules
To claim an education tax credit, the following rules must be satisfied:
- Married couples must file jointly.
- Expenses must be incurred for academic periods beginning in the applicable tax year and prepayments made for qualified expenses for the first 3 months of the following year. However, prepayments in the applicable tax year for the following year expenses that would ordinarily be incurred after March will not qualify for the credit of either year; the following year credit will not be applicable because the payments were made in the prior year, even though it was for expenses that would be incurred for the following year.
A credit cannot be claimed for any expenses that were deducted or for which other financial assistance has been received. In the case of parents and a dependent child, only one can claim the credit.
All of the credits can be applied for higher education tuition, including for college and graduate programs, or for vocational training. Generally, eligible institutions include any that are eligible for student aid programs administered by the United States Department of Education, which includes most accredited schools. The taxpayer claiming the credit must be paying the expenses for himself, his spouse, or any claimed dependents.
Qualified expenses include, besides tuition, student activity fees, course related books, supplies, and equipment required to be purchased by the educational institution. Books or equipment that are not required by the school can qualify for the American Opportunity credit but not the Lifetime Learning credit. Eligible expenses include expenses that were paid with borrowed money. Expenses that are not qualified include room and board, insurance, and medical expenses, transportation, and other personal expenses.
Qualified expenses must be reduced by tax-free scholarships, Pell grants, veterans' education assistance or employer-provided educational assistance. The educational institution may provide Form 1098-T, Tuition Statement that shows the amount of qualified expenses as well as any reductions because of scholarships, grants, reimbursements, or adjustments to expenses. However, the credit can only be claimed for actual expenses paid in the applicable tax year, which may not be reported on Form 1098-T.
Only the taxpayer who claims the child as a dependent can claim the credits, unless he decides not to claim the credit, so that the child can do so, which would be advantageous for parents whose income exceeds the income eligibility for the credits. Even if a third-party, such as a grandparent pays for the child's expenses, the parent can still claim the credit, since the child is his dependent. The grandparent can only claim the credit if the child is her dependent.
A credit can be claimed for students who receive a tax-free distribution from a Coverdell Education Savings Account (ESA) or a qualified tuition program (QTP). However, the expenses paid by these distributions reduce the amount of eligible expenses that can be claimed for the credit. A previously claimed credit may have to be recaptured and reported as income if the taxpayer received tax-free educational assistance or a refund of an expense that was used for a prior year credit.
The credits are also reduced by income that was excluded from gross income, such as gifts or inheritance. Expenses that remain after being reduced by educational credits and distributions from ESAs or QTPs can be used to determine the exclusion amount for United States Savings Bonds. The 10% tax penalty that is normally assessed on excess distributions from ESAs or QTPs does not apply if the excess was caused by claiming an educational credit.
Starting in 2018, under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, 529 plans may be used to pay for K-12 private school tuition, which will help families who send their children to private school.
American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) is a modification of the Hope Scholarship credit that applies to tax years 2009 and thereafter. The AOTC offsets up to $2,500 of qualified expenses for each eligible student in the first 4 years of college or other secondary institution. The credit covers 100% of the first $2,000 and 25% of the next $2,000 of qualified expenses, for a maximum of $2,500 per eligible student. Qualified expenses include tuition, fees, books, supplies, equipment, and reasonable room and board.
An eligible student must be enrolled in an accredited institution, that provides a degree or other recognized educational credential, and must take at least 1/2 of the normal full-time workload for at least 1 academic period, and the student must not have any felony convictions for the possession or distribution of a controlled substance. The eligible student must also be the taxpayer, spouse, or a dependent who is claimed as a dependent by the taxpayer. The student will be ineligible if:
- their filing status is married filing separately
- they cannot be claimed as a dependent by someone other than the taxpayer, or
- they were a nonresident alien for any part of the tax year, but they did not elect to be treated as a resident alien for tax purposes
If the taxpayer does not claim the student as a dependent, then only the student can claim the AOTC, even if the student cannot claim their own exemption.
The AOTC can offset both regular income tax liability and AMT liability. Since 40% of the credit is refundable, $1,000 of the maximum credit of $2,500 is refundable; thus, it is 1 of the few credits that can also be used to offset self-employment tax. However, none of the credit is refundable for a child subject to the kiddie tax.
The AOTC can only be claimed for 4 years, which is reduced by each year that either the AOTC or the Hope credit was claimed in earlier years.
Hope Scholarship Tax Credit
The Hope Scholarship tax credit was much like the AOTC except that it only paid for 100% of the first $1,000 of qualified tuition expenses plus 50% of an additional $1,000 paid during the year. It had the same eligibility requirements as the AOTC, but the Hope credit was expanded in 2009 by the American Recovery and Reinvestment Act of 2009 and renamed the AOTC. The AOTC was slated to expire 2017, but it was made a permanent part of the tax code. Nonetheless, if the Hope credit was claimed in previous years for any eligible student, then that will reduce the number of years available for claiming the AOTC for that student.
Lifetime Learning Credit
The Lifetime Learning credit can offset up to $2,000 of qualified expenses if the taxpayer, spouse, or dependents are enrolled in an eligible educational institution. The credit is nonrefundable, meaning that the amount of the credit is limited to the taxpayers' ordinary income tax liability, and it is not indexed for inflation. Besides tuition, the only other qualified expenses are those required by the school and paid to the educational institution. There is no degree or workload requirement, and no limit on the number of years that the Lifetime Learning credit can be claimed, so it is not limited to the first 4 years of postsecondary education. The credit applies to the first 20% of the first $10,000 paid in the applicable tax year, which is the aggregate total for all family members claiming the credit. So, unlike with the American Opportunity credit, a taxpayer with several children that are eligible for the credit can only claim a maximum of $2,000 for all children.
The American Opportunity credit is generally superior because of the higher limit of $2,500 that applies to each eligible family member who incurs qualified educational expenses and, additionally, 40% of the credit is refundable. However, the American Opportunity credit phases out at lower income levels.
Modified Adjusted Gross Income Phaseout Rules
Like most credits, there are phaseout rules for the educational tax credits based on modified adjusted gross income (MAGI). MAGI equals adjusted gross income (AGI) before any deduction for qualified educational expenses plus:
- the exclusion for foreign earned income,
- the foreign housing exclusion or deduction, or
- excluded income from Puerto Rico or American Samoa
For most taxpayers, MAGI equals AGI before the deduction for qualified educational expenses is subtracted.
The phaseout threshold for the American Opportunity credit is $80,000 and the phaseout limit is $90,000; both amounts are doubled for married couples filing jointly.
|2016 - 2018||$80,000 ($160,000)||$90,000 ($180,000)|
|2015||$80,000 ($160,000)||$90,000 ($180,000)|
|2014||$80,000 ($160,000)||$90,000 ($180,000)|
|2013||$80,000 ($160,000)||$90,000 ($180,000)|
|2012||$80,000 ($160,000)||$90,000 ($180,000)|
|2011||$51,000 ($102,000)||$61,000 ($122,000)|
|Credit||=||Credit without Phaseout||×|| MAGI Limit – MAGI |
Example of MAGI Phaseout Rules
Suppose you, as a single taxpayer, earned $86,000 for 2013 and would be eligible to claim an American Opportunity credit of $1,000 if phaseout rules did not apply. Because your income is greater than the phaseout threshold of $80,000 , but less than the MAGI limit of $90,000 for the credit and the phaseout range = $90,000 – $80,000, the credit that you can claim is calculated thus:
|Available Credit||=||$1,000||×||$90,000 – $86,000 |
|2018||$57,000 ($114,000)||$67,000 ($134,000)|
|2017||$56,000 ($112,000)||$66,000 ($132,000)|
|2016||$55,000 ($111,000)||$65,000 ($131,000)|
|2015||$55,000 ($110,000)||$65,000 ($130,000)|
|2014||$54,000 ($108,000)||$64,000 ($128,000)|
|2013||$53,000 ($107,000)||$63,000 ($127,000)|
|2012||$52,000 ($104,000)||$62,000 ($124,000)|
|2011||$51,000 ($102,000)||$61,000 ($122,000)|
If your MAGI is greater than the phaseout amount, then you may waive the dependency exemption for your child to allow her to claim the credit if she has sufficient taxable income that can be reduced by the credit.