Educational Tax Credits

The law provides for two nonrefundable tax credits, the American Opportunity (or Hope Scholarship credit) and the Lifetime Learning Credits. Both credits will reduce a taxpayer's tax liability dollar for dollar until the tax reaches zero. Any Hope or Lifetime credit in excess of the tax liability is lost. The American Opportunity credit provides for a partial excess credit refund. The credit is not allowed for taxpayers who file married separate returns. The credits are elective and the taxpayer must choose between the two credits for each student.

AMERICAN OPPORTUNITY CREDIT

The American Opportunity credit has been extended for two more years and replaces the Hope education credit for 2009 through 2012, providing an increased and expanded credit. Where the Hope credit only applied to the first two years of post-secondary education, the American Opportunity credit will be available for four years of college, and the maximum credit per student increases to $2,500. The credit will be based on 100% of the first $2,000, and 25% of the next $2,000, of tuition, fees and course material (including books) expenses paid during the tax year. 40% of the credit is refundable, provided the taxpayer is not: (1) a child under the age of 18 or (2) under the age of 24, a full-time student and is not self-supporting. Except as noted above, the other qualifications and restrictions that apply to the Hope credit also apply to the American Opportunity credit.

For higher-income taxpayers, this credit begins to phase out for AGI in excess of $80,000 ($160,000 for married couples filing jointly), an increase from the previous phase-out thresholds of $50,000/$100,000.

LIFETIME LEARNING CREDIT

The Lifetime Learning Credit is a credit of up to 20% of the first $10,000 of qualifying educational expenses for (1) undergraduate, graduate, or certificate level courses for a student attending classes on at least a half-time basis, or (2) any course at an eligible institution to acquire or improve job skills of the student (no attendance time requirements).

Example: A taxpayer has two children attending college on a full-time basis. The taxpayer pays qualified tuition expenses for the two children in the amount of $12,500, and there is no reimbursement or other tax benefit claimed for the tuition expense. The taxpayer is entitled to a tax credit of $2,000 (20% of the first $10,000) for the tax year.

Qualifying expenses...for both credits include tuition and fees but generally not expenses for room, board, equipment*,materials*, books* and other nonacademic fees such as student activity, athletic, insurance, etc. Also excluded are expenses for courses that involve sports, games or hobbies that are not part of a degree program. Tax-free scholarships or fellowships and other tax-free educational benefits must reduce expenses qualifying for the credit. *However books and certain other materials that are provided by the school and included in the tuition and fees may also be deductible.

Qualifying students...must attend a qualified educational institution (one that is eligible to participate in U.S. Dept. of Education student aid programs). The student must be the taxpayer, spouse, or someone who is a dependent of the taxpayer. In addition, in the case of the Hope Scholarship Credit, the student must have no federal or state felony drug convictions for the academic period to which the credit would apply.

The allowable credit phases out when a taxpayer's modified 2011 AGI is between $51,000 and $61,000 for single taxpayers and between $102,000 and $122,000 for joint return filers. These phase-out levels are annually adjusted for inflation.

HOPE SCHOLARSHIP CREDIT

CAUTION The Hope Credit Is Generally Not Effective for 2009 through 2012.

The Hope Scholarship Credit is a credit of up to $1,800 (2008 amount) per student per year, covering the first two years of post-secondary education. The credit is 100% of the first $1,200 of qualifying expenses plus 50% of the next $1,200.

Example: A taxpayer's child is in the first year of college, attending on a full-time basis. The tuition that is paid during the year by the taxpayer is $1,600, and there is no reimbursement or other tax benefit claimed for the tuition expense. The taxpayer is entitled to a tax credit of $1,300 (100% of the first $1,100 plus 50% of balance) for the tax year.

Generally, for most college students, their first term in college begins in the fall of the year they graduate from high school, and their first two years of post-secondary education is spread over the subsequent three-year period. Since the Hope credit can only be taken in two calendar tax years, it may be appropriate to elect out of the Hope Credit the first year and instead use the Lifetime Learning Credit.

The allowable credit phases out when a taxpayer's modified AGI is between $50,000 and $60,000 for single taxpayers and between $100,000 and $120,000 for joint return filers. These phase-out levels are annually adjusted for inflation.

Who claims the credit? The taxpayer who claims the credit is not necessarily the one who pays the tuition.