33.7 Education Tax Credits
For 2012, there are two tax credits for higher education tuition and qualified fees: The American Opportunity credit and the lifetime learning credit. Both credits are figured on Form 8863. You may not claim both credits for the same student for the same year.
The maximum American Opportunity credit is $2,500 per eligible student for qualified expenses in the first four years of post-secondary education. 40% of the credit is generally refundable, meaning that it is allowed even if it exceeds your tax liability. See 33.8 for details on the American Opportunity credit.
Unlike the American Opportunity credit, the Lifetime Learning credit may be claimed for higher education costs beyond the fourth year of post-secondary education and for non-degree courses that enable the student to acquire or improve job skills. Only tuition and fees/expenses required for enrollment or attendance qualify. The maximum Lifetime Learning credit is $2,000 annually, regardless of how many students you pay expenses for. See 33.9 for details on the Lifetime Learning credit.
Law Alert
A phaseout rule based on modified adjusted gross income (MAGI), may limit or even eliminate both credits. However, the American Opportunity credit phases out over a higher MAGI range (33.8) than the Lifetime Learning credit (33.9).
Some of the qualification rules for the American Opportunity and Lifetime Learning credits are the same and these are discussed below.
Rules Applicable to Both the American Opportunity Credit and Lifetime Learning Credit
Married persons filing separately are not eligible.
If you are married at the end of the year, you must file jointly to claim either the American Opportunity credit or the Lifetime Learning credit.
Borrowed funds used to pay expenses.
You can claim either the American Opportunity credit or the Lifetime Learning credit for eligible expenses paid with loan proceeds. If loan proceeds are sent directly to the educational institution, they are not considered paid until the institution credits the student’s account.
Prepaid expenses.
Your American Opportunity or Lifetime Learning credit for 2012 is based on qualified expenses you paid in 2012 for academic periods beginning in 2012, as well as 2012 payments of qualified expenses for academic periods beginning in the first three months of 2013. If you made a payment in 2012 for academic periods beginning after March 2013, the payment is not eligible for a 2012 credit or a 2013 credit.
Qualified expenses for eligible students at eligible educational institutions.
To claim an American Opportunity credit or a Lifetime Learning credit you must pay qualified expenses for yourself, your spouse, or dependents claimed as exemptions on your return. The expenses must be for courses at eligible educational institutions. Specific student eligibility requirements for the American Opportunity credit are discussed at 33.8. An eligible educational institution is any accredited public, nonprofit, or proprietary college, university, vocational school, or other postsecondary institution eligible to participate in the student aid programs administered by the U.S. Department of Education.
For both credits, qualified expenses include tuition, student activity fees that are required of all students for enrollment or attendance, and course-related books, supplies, and equipment that must be purchased from the educational institution as a condition of enrollment or attendance. Other required course materials, such as books or equipment bought privately, qualify for the American Opportunity credit but not the Lifetime Learning credit. Expenses for sports or hobby-related courses that are not part of the student’s degree program do not qualify for the American Opportunity credit but such non-degree courses qualify for the Lifetime Learning credit if they help the student acquire or improve job skills. Room and board, insurance, medical expenses, transportation, and other personal expenses are not qualified expenses for either credit.
For purposes of figuring either credit, qualified expenses must be reduced by tax-free scholarships, Pell grants, Veteran’s educational assistance or employer-provided educational assistance (3.7).
On Form 1098-T, the educational institution may report to the enrolled student the amount of qualified expenses received or billed during the year, as well as any scholarships, grants, reimbursements or adjustments to expenses that could reduce the allowable credit. The credit must be based on actual payments in 2012, which may not be reflected on Form 1098-T.
Who can claim a credit for expenses paid by your child or by a third party?
A dependent’s expenses are treated as the expenses of the taxpayer claiming an exemption (21.1) for the dependent. For example, if your child is an eligible student and pays qualified expenses, and you claim an exemption for your child as a dependent on your tax return, only you can claim a credit for his or her expenses. Because you claim the child as your dependent, his or her payment of qualifying expenses is treated as your payment.
If a third party, such as the child’s grandparent, pays tuition and related expenses for the child directly to a college, the student is treated as receiving the payment from the other person and making the payment to the school. If you claim a dependency exemption for your child, you treat the expenses as your own and may base a credit on the expenses. If the grandparent meets the support test for the child and claims the dependency exemption, the grandparent could use the expenses to claim a credit. The child can claim a credit based on the payment only if no one claims him or her as a dependent.
Qualified expenses paid directly to a school for a dependent under a court-approved divorce decree are also treated as paid by the dependent.
Waiving exemption deduction for your child so child can claim credit.
Your child may claim a credit if you are eligible to claim an exemption for him or her as your dependent (21.1) but you do not do so. If you would not be allowed a credit for your dependent child’s expenses because of the MAGI phaseout (see 33.8 for American Opportunity credit and 33.9 for Lifetime Learning credit), and your child has tax liability against which the credit may be claimed, you can forego claiming the child as a dependency exemption on your return, which would allow the credit to be claimed on the child’s return. However, if the child is subject to the kiddie tax, as most students under age 24 are (24.2), he or she cannot claim the refundable American Opportunity credit (33.8); his or her entire credit will be treated as nonrefundable.
Make alternative tax calculations to determine whether an exemption for you or a credit for your child would produce the larger overall tax savings.
Double benefits not allowed.
You may not claim an American Opportunity credit and the Lifetime Learning credit for the same student for the same year. If you claim either credit, you may not claim the above-the-line tuition and fees deduction (33.12) for the same student for the same year.
You may be able to receive a tax-free distribution from either a Coverdell ESA or a state qualified tuition program (QTP) in the same year that you claim an American Opportunity credit or lifetime learning credit. The expenses taken into account as the basis of an American Opportunity or lifetime learning credit reduce eligible expenses for purposes of figuring the tax-free part of an ESA or state QTP distribution.
Recapture of credit.
If you claim a credit and after you file your return for that year you receive tax-free educational assistance for the prior year or receive a refund of an expense used to figure the prior-year credit, you have to refigure the original credit. If the refund or assistance would have reduced the original credit, the amount of the reduction must be added to your tax liability for the year you receive the refund or assistance; see the Form 8863 instructions.