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What Tax Credits Are Available For Higher Education?

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Did you know that there is not just one but TWO tax credits available to offset an individual's income tax obligation if he or she paid for higher education during the tax year? An eligible student may qualify for both the American Opportunity Tax Credit and the Lifetime Learning Credit.

These education credits are generally a percentage of the "qualified tuition and related expenses" paid during the year, which include the following:

  • Tuition and fees required for the enrollment and attendance of the taxpayer, his or her spouse or dependents at an eligible educational institution. 26 U.S.C. §25A(f)(1)(A).
  • Qualified expenses do not include "any course or other education involving sports, games, or hobbies, unless such course or other education is part of the individual's degree program." 26 U.S.C. §25A(f)(1)(B).
  • Qualified expenses do not include "student activity fees, athletic fees, insurance expenses, or other expenses unrelated to an individual's academic course of instruction." 26 U.S.C. §25A(f)(1)(C).
  • For purposes of the American Opportunity Credit, qualified expenses include required course materials. 26 U.S.C. §25A(f)(1)(D).

However, the amount of "qualified tuition and related expenses" taken into account for either educational credit shall be reduced by the following:

  • A qualified scholarship excludable from gross income. 26 U.S.C. §25A(g)(2)(A).
  • An educational assistance allowance or grant. 26 U.S.C. §25A(g)(2)(B).
  • A payment (other than a gift, bequest, devise, or inheritance) for such individual's educational expenses, or attributable to such individual's enrollment at an eligible educational institution, which is excludable from gross income under any law of the United States. 26 U.S.C. §25A(g)(2)(C).

For example, a taxpayer has a tuition bill of $10,000.00, but $6,000.00 was paid by a scholarship and $2,000.00 was paid by another relative as a gift, leaving a balance of $2,000.00 to be paid by the taxpayer. The "qualified tuition and related expenses" that the taxpayer can consider for educational credits is $4,000.00. Although the amount that may be considered is reduced by the $6,000.00 scholarship, the $2,000.00 paid by the relative is not counted due to being a gift.

However, the following taxpayers are excluded from claiming any educational credits:

  • A payer who is claimed as the dependent of another taxpayer. 26 U.S.C. §25A(g)(3).
  • A taxpayer who is a non-resident alien individual for any portion of the tax year. 26 U.S.C. §25A(g)(7).

AMERICAN OPPORTUNITY TAX CREDIT

The American Opportunity Tax Credit is equal to the sum of:

  • 100% of the qualified tuition and related expenses paid by the taxpayer during the tax for education furnished to the eligible student up to $2,000.00. 26 U.S.C. §25A(b)(1)(A).
  • PLUS 25% of the qualified tuition and related expenses so paid that exceeds $2,000.00 but only up to $4,000.00 total. 26 U.S.C. §25A(b)(1)(B).

For example, a taxpayer pays $3,000.00 in tuition fees in 2019 to pay for his daughter to go to school. Assuming that the taxpayer is otherwise eligible to claim the American Opportunity Tax Credit, he can claim 100% of the first $2,000.00 of expense and 25% of the next $1,000.00. Thus, the taxpayer's tax credit is $2,000.00 + $250.00 (25% of $1,000.00) = $2,250.00. The maximum credit available is $2,500.00.

In addition, 40% of the American Opportunity Tax Credit is refundable. 26 U.S.C. §25A(i). This means that if the taxpayer's total tax obligation falls below zero, up to 40% of the available credit may still be refunded to the taxpayer.

The American Opportunity Tax Credit has the following conditions:

  • The credit is only allowed for the tax year if the eligible student is carrying at least one-half of the normal full-time workload for his or her course of study. 26 U.S.C. §25A(b)(2)(B).
  • The credit is only allowed for the first four years of postsecondary education at an eligible educational institution (not graduate school or law school). The student must be in a program that leads to a degree, certificate or other recognized educational credential. 26 U.S.C. §25A(b)(2)(C).
  • The credit is completely disallowed to any student who "has been convicted of a federal or state felony offense consisting of the possession or distribution of a controlled substance..." 26 U.S.C. §25A(b)(2)(D).
  • The credit is only allowed if both the taxpayer and the student had a taxpayer identification number (TIN) issued to them before the end of the tax year, and that the employer identification number of the educational institution is included on the tax return. 26 U.S.C. §25A(g)(1)(B).

A taxpayer is subject to the following income thresholds for claiming the American Opportunity Tax Credit in 2019:

  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income less than $80,000.00 ($160,000.00 if married filing jointly) can claim the entire amount.
  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income of $80,000.00 or more but less than $90,000.00 ($160,000.00 or more but less than $180,000.00 if married filing jointly) will see the amount of the credit phased out.
  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income of $90,000.00 or more ($180,000.00 or more if married filing jointly) will not be eligible to claim the credit.

A taxpayer who makes a reckless or fraudulent claim for the American Opportunity Tax Credit in a prior tax year will be prohibited from making a future claim during a disallowance period:

  • The disallowance period is "the period of 2 taxable years after the most recent taxable year for which there was a final determination that the taxpayer's claim of the American Opportunity Tax Credit under this section was due to reckless or intentional disregard of rules and regulations (but not due to fraud)." 26 U.S.C. §25A(b)(4)(A)(ii)(II).
  • The disallowance period is "the period of 10 taxable years after the most recent taxable year for which there was a final determination that the taxpayer's claim of the American Opportunity Tax Credit under this section was due to fraud." 26 U.S.C. §25A(b)(4)(A)(ii)(I).

Before a disallowed taxpayer can claim the credit again, he or she must file Form 8862 with the Internal Revenue Service providing certain information why the taxpayer should be allowed to claim the credit again. Failure to provide Form 8862 to the IRS when required can lead to another disallowance period in addition to any other penalties and interest that can be assessed.

LIFETIME LEARNING CREDIT

The Lifetime Learning Credit is equal to 20% of the qualified tuition and related expenses paid by the taxpayer during the taxable year for education furnished during any academic period that does not exceed $10,000.00. 26 U.S.C. §25A(c)(1). For example, a taxpayer pays $5,000.00 to go to law school at night. Assuming that the taxpayer is otherwise eligible to claim the Lifetime Learning Credit, he can claim 20% of the $5,000.00 he paid for a total credit of $1,000.00. The maximum credit available is $2,000.00.

The Lifetime Learning Credit has the following conditions:

  • Any amounts of qualified tuition and related expenses considered for calculating the American Opportunity Tax Credit cannot be used to calculate the Lifetime Learning Credit (although if there are sufficient expenses to claim both credits, the taxpayer may do so if otherwise eligible). 26 U.S.C. §25A(c)(2)(A).
  • The taxpayer is not required to be in a 4-year programs and can use the credit " with respect to any course of instruction at an eligible educational institution to acquire or improve job skills of the individual." 26 U.S.C. §25A(c)(2)(B).

A taxpayer is subject to the following income thresholds for claiming the Lifetime Learning Credit in 2019:

  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income less than $58,000.00 ($116,000.00 if married filing jointly) can claim the entire amount.
  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income of $58,000.00 or more but less than $68,000.00 ($116,000.00 or more but less than $136,000.00 if married filing jointly) will see the amount of the credit phased out.
  • A taxpayer claiming single, head of household or qualifying widow(er) with modified adjusted gross income of $68,000.00 or more ($136,000.00 or more if married filing jointly) will not be eligible to claim the credit.

Unlike the American Opportunity Tax Credit, a claimant for the Lifetime Learning Credit does NOT have to be in a degree or certificate program, is NOT limited to 4-years and is NOT barred due to a prior state or federal drug conviction. However, no portion of the Lifetime Learning Credit is refundable.

If the taxpayer has qualified educational expenses for an academic period which begins during the first 3 months of the next tax year, then it shall be treated as made during the current tax year. 26 U.S.C. §25A(g)(6). For example, if the taxpayer prepays in 2019 for a college semester beginning in January 2020, then those expenditures may be available for the educational tax credits in the 2019 tax year.

Both educational credits may be claimed by filing Form 8863 with your federal tax return. You may claim these credits whether you itemize your deductions or claim the standard deduction. The American Opportunity Tax Credit and the Lifetime Learning Credit are a great tax break for eligible students trying to work their way through college. Don't leave this valuable money on the table!

If you have questions about the educational credits or any other aspect of federal taxation, then do not hesitate to contact the attorneys at Kershaw, Vititoe & Jedinak PLC today.

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