Education Tax Credit Nuances — Don’t Leave Money on the Table

There are actually two higher-education tax credits. The American Opportunity Tax Credit (AOTC) provides up to $2,500 worth of credit for each student, 40% of which is refundable. The credit is equal to 100% of the first $2,000 of college tuition and qualified expenses and 25% of the next $2,000. The AOTC only applies to the first 4 years of post-secondary education.

The other credit is the Lifetime Learning Credit (LLC), which only provides a maximum $2,000 of credit (20% of up to $10,000 of eligible expenses) per family. None of it is refundable, meaning it can only be used to offset the taxpayer’s tax liability, and any additional credit amount is lost.

When it comes to these credits, it is easy to leave money on the table. Here are the reasons why:

  1. Many students attend local colleges for the first two years and then transfer to a university for the remainder of their education. Knowing the university tuition will be higher, some parents take the LLC and wait on the AOTC, thinking they can use it in years with higher tuition and get a larger credit. What they don’t realize is that the AOTC credit is only good for the first four years of post-secondary education. Thus, it is always better to claim the AOTC in the first four years.
  2. Parents don’t realize what constitutes a year of post-secondary education. Most students start college in the autumn after their May or June graduation from high school. Thus, for them, the first four years of post-secondary education actually span parts of five calendar years, and as a result, the student will qualify for the AOTC in five calendar years. With careful planning, students can qualify for the full $2,500 of the refundable credit in all five calendar years.
  3. A special rule allows the tuition for an academic period that begins in the first three months of the next year to be paid in advance and thus increase the amount of tuition qualifying for the credit in the year the tuition is paid. This allows for planning when to make tuition payments to maximize credits, especially in the first partial calendar year.
    Example: Cameron just graduated from high school and will be beginning college in September. Her tuition and credit-qualifying expenses for the semester covering the last four months of the year and January of the next year are $1,500. Her mother, Tricia, is aware of the 3-month rule, and in December she prepays Cameron’s $1,500 tuition for the semester beginning February 1 of the next year, bringing the qualifying expenses to a total of $3,000. The AOTC is equal to 100% of the first $2,000 of qualifying expenses and 25% of the next $2,000. Thus the AOTC for Cameron is $2,250 ($2,000 + 25% of $1,000). Tricia could increase the credit for the year to the full $2,500 maximum by purchasing $1,000 worth of course materials needed for “meaningful attendance or enrollment” in Cameron’s course of study.
  4. Qualifying expenses other than tuition are often overlooked, especially in light of a recent tax regulation change that specifies for the AOTC that qualifying expenses include course materials needed for “meaningful attendance or enrollment” whether purchased from the school or an outside vendor. Previously, only course material purchased from the school qualified (and this is still the rule for the Lifetime Learning Credit). This is a significant change and opens up the possibilities of including expenses not previously allowed.
  5. Taxpayers also often overlook another very important fact: Whoever claims the tax exemption for the student gets to claim the education credit even if someone else paid for the tuition and qualified expenses.
    Example: Suppose Cameron’s Uncle Lee pays her tuition but Tricia, her mother, claims Cameron on her tax return. Tricia is the one who qualifies for and receives the credit.
  6. What many also overlook is the fact that the AOTC is phased out for higher-income taxpayers based on their adjusted gross income (AGI). It phases out for AGIs between $160,000 and $180,000 for married taxpayers filing jointly, and between $80,000 and $90,000 for others. The LLC phases out a little quicker than the AOTC: between $112,000 and $132,000 for joint filers and between $56,000 and $66,000 for others. As an exception, married taxpayers filing separately aren’t eligible to claim either credit. (Note: the LLC phaseout ranges are adjusted for inflation annually, and the one quoted is for 2017.)
    Thus, in cases when the parent claiming the student has an AGI above the phaseout range, regardless of who paid the tuition and qualified expanses, no one will be able to claim the credit. So it is important to consider the income of the individual who is claiming the student when there is an option of who claims the child, such as in cases of divorced parents.
  7. Because of gift tax issues, a person other than the one qualifying for the credit, such as a grandparent, may hesitate to volunteer to pay a tuition expense. Where payments are made directly to the educational institution, they are excluded from gift tax rules. However, depending on the amounts involved, there may be a gift tax reporting requirement if a monetary gift is given to the student or the individual who is claiming the credit and then the gift money is used to pay tuition.
  8. A question often arises as to whether tuition payments to a trade school or foreign university will count toward the education credit. To qualify for the credit, the tuition must be paid to any accredited public, nonprofit or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This would rule out foreign educational institutions because they don’t qualify for the student aid program administered by the Department of Education, but it would generally include most accredited public nonprofit or privately owned, profit-making post-secondary educational institutions in the U.S.

As you can see, there are several nuances associated with the education credits that must be considered. Please call this office if you need assistance with education planning or the application of the education tax credits to your particular circumstances.

Qualifying for the Work Opportunity Tax Credit

If you are an employer who is willing to help disadvantaged individuals, you could benefit from a substantial federal tax credit. Hiring certain new employees can qualify you for the work opportunity tax credit (WOTC).

The WOTC is typically worth up to $2,400 for each eligible employee, but it can be worth up to $9,600 for certain veterans and up to $9,000 for “long-term family assistance recipients.” The credit is available for eligible employees who begin working for you before January 1, 2020.

Generally, an employer is eligible for the WOTC only when paying qualified wages to members of any of the targeted groups listed below. For more details on the required qualifications for each group, see the instructions for IRS Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit).

  1. Qualified IV-A recipients — generally, members of a family that is receiving assistance under the Temporary Assistance for Needy Families (TANF) program;
  2. Qualified veterans;
  3. Qualified ex-felons – generally, those hired within one year of release;
  4. Designated community residents — those who are aged 18 through 39 and who are living in an empowerment zone or a rural renewal area*;
  5. Vocational rehabilitation referrals — handicapped individuals who are referred by rehabilitation agencies;
  6. Qualified summer youth employees — those who are 16 or 17 years old, have never previously worked for the employer and reside in an empowerment zone*;
  7. Qualified members of families who participate in the Supplemental Nutritional Assistance Program (SNAP);
  8. Qualified Supplemental Security Income recipients;
  9. Qualified long-term family assistance recipients — those receiving TANF assistance payments; and
  10. Qualified long-term-unemployed individuals.
    * Both empowerment zones and rural renewal areas are listed in the IRS Form 8850 instructions.

For an employer to qualify for the credit, the employee must work a minimum of 120 hours and receive at least 50% of his or her wages from that employer for working in the employer’s trade or business. Relatives of the employer and employees who have previously worked for the employer do not qualify for the credit.

For an employee from most of the targeted groups, the credit is based upon the first $6,000 of first-year wages. If an employee completes at least 120 hours but less than 400 hours of service for the employer, the credit is equal to those wages multiplied by 25%. If the employee completes 400 or more hours of service, the credit is equal to the wages multiplied by 40%. Thus, the maximum credit per employee in one of these groups would be $2,400 (.4 x $6,000). For the summer youth employees, only the first $3,000 of the first-year wages are taken into account, resulting in a maximum per-employee credit of $1,200 (.4 x $3,000).

Two categories allow for higher first-year wages to be taken into account when calculating the credit:

  • Long-term family assistance recipients — For this category, the first-year wage that can be taken into account for the credit is increased to $10,000, thus allowing a maximum credit of $4,000 (.4 x $10,000). In addition, this group qualifies for a credit in the second year (immediately following the first year); this is equal to 50% of second-year wages up to $10,000.
  • Veterans — The three possible qualifications of veterans have applicable first-year wages for the credit of up to $12,000, up to $14,000 and up to $24,000. Thus, the maximum credit for this group is between $4,800 (.4 x $12,000) and $9,600 (.4 x $24,000), depending upon the qualification.

Certification Process — To be eligible to claim the WOTC, the employer must file Form 8850 with its state workforce agency no later than 28 days after an eligible employee begins work. Once the worker is state-certified as a member of a targeted group and has worked sufficient hours, the employer can claim the WOTC on Form 5884 (Work Opportunity Credit).

Other Issues:

  • No Dual Benefits — No deduction is allowed for the portion of wages equal to the WOTC for that tax year.
  • Unused Current-Year Credit — The credit is included in the general business credit, and if an employer’s credit is greater than its income-tax liability (including the alternative minimum tax), the excess credit is considered an unused credit that is available for use on another year’s return. The unused credit is first carried back one year (generally by amending the return for the carryback year) and then carried forward until any remaining credit is used up (but for no more than 20 years).

In some circumstances, electing not to claim the credit is more beneficial for the employer. Please call us for additional information related to the WOTC and to see if it would be beneficial in your particular tax circumstances.

Did You Have to Repay Part of Your Obamacare Subsidy and Don’t Know Why?

As part of Obamacare, most everyone is required to be insured or pay a penalty. However, this created a substantial financial burden for lower-income families. To alleviate this situation, Obamacare included a subsidy, referred to as the premium tax credit (PTC), to help them pay the cost of the insurance.

That credit is based on family size, household income, household income in relationship to the federal poverty line tables and the cost of the family’s insurance.

The primary variable in determining the actual credit is the family’s household income, so the exact amount of the PTC cannot be determined until after the close of the tax year. Providing the credit after the fact on the tax return for the year does not help families to pay their premiums during the year, so to alleviate that problem, Obamacare allows families to estimate their family income when they apply for their insurance, and the government insurance marketplaces will estimate the PTC and allow it as a subsidy in advance. That subsidy is called the advance premium tax credit (APTC) and reduces the amount of the insurance premiums that the family must pay during the year.

Then, when the tax return for the year is prepared, the actual household income is known, and the actual PTC to which the family is entitled is determined. If the PTC is greater than the APTC, then the difference is credited on the tax return. However, if the APTC – the subsidy paid in advance – is greater than the actual PTC the family is entitled to, then the difference must be repaid.

So, if you had to repay some amount of the credit, it was generally due to your household income being underestimated when you signed up for the insurance, thus causing the APTC to be larger than the PTC. This is one of the hazards of estimating your household income in advance because you may receive unexpected income during the year, such as a raise, a bonus, a spouse starting to work, selling some stocks for a gain…the list goes on.

There are other reasons for a mismatch between the APTC and PTC. For instance, if your employer offered you affordable, compliant insurance for any month during the year, then you were not eligible for the PTC that month. (The IRS knows when this occurred based on a report that employers have to file.) Other things that can change the PTC include changes in family size created by marriage, divorce, children getting married, deaths, etc. Another reason is when a married couple is receiving APTC from the marketplace and files married filing separate (MFS) returns instead of filing jointly. The MFS filing status does not allow them to claim the PTC.

You can mitigate the repayments by keeping the insurance marketplace updated on your estimated family income and family size and allowing it to make appropriate adjustments to the APTC.

If you have questions related to the premium tax credit or the repayments, please give us a call.

Is Solar Energy Right for You?

It seems like you can’t watch TV these days without being exposed to home solar ads touting free electricity and big tax credits. Be careful, as these savings and tax credits may not be all that they are advertised to be; this depends upon your financial and tax circumstances. Home solar is not necessarily the best option for everyone. Before you take the leap, please take a moment to consider the tax and financial aspects of solar electric systems as they apply to your circumstances. Once you’ve done so, you can make an educated decision.

Do You Really Need It? – Although nearly everyone wants to help the environment by reducing the use of fossil fuels, not every household uses enough electricity to warrant the expense of installing solar. Thus, the first step in your analysis should be to look at your annual electricity costs to see how long it will take for the projected savings to pay off the system. Be sure to also consider how many years you plan to stay in your present home, as if you expect to move soon, you likely won’t recover your costs before selling the home.

System Cost – If you decide to install solar, shop around and do your research to find reliable contractors with good reputations. Get multiple quotes and compare them not only for cost, but also in terms of warranties, features, and kilowatt output.

Financing – This is one of the key issues that you need to carefully consider in making your decision. Systems typically cost $20,000 or more, and this depends on the home’s size and electricity needs. If you plan on financing the system, you need to be very conscious of loan interest rates, which can substantially impact the overall cost.

CAUTION: Some municipalities have set up programs through which the loan for the purchase of a solar electric system is added as a lien on the home; the payments are then made along with property tax payments. Unfortunately, the interest rates for these programs are generally substantially higher than the rates for other sources. All too frequently, the borrowers are led to believe that the payments are deductible as property taxes, but, in fact, only the interest portion of the payments are deductible as home mortgage interest.

Solar Tax Credit – As an incentive to persuade homeowners to install solar electric systems in their homes, the federal government offers a tax credit equal to 30% of the cost of solar installation (if for a primary or secondary home). However, the credit is nonrefundable, which means that it can only be used to offset tax liability; any amount of credit that is not used in the current year carries forward, however. Depending upon your circumstances, you may not even derive a meaningful benefit from the credit. Line 47 on the 1040 tax form represents your tax liability for the year, and the solar tax credit can only be used to offset that amount. In addition, the solar credit is being phased out; the credit on new installations drops to 26% in 2019 and 22% in 2021, the last year of the credit.

Another issue is that the credit is not allowed if you lease a solar electric system instead of purchasing it.

Interest Deduction – Because the addition of a solar electric system would be treated as a home improvement, if your loan to finance a system is secured by your home, the interest is deductible as home mortgage acquisition interest – provided that you itemize your deductions and that the sum of all your primary and secondary home acquisition debt does not exceed $1 million.

The final issue is whether you can actually afford the solar electric system. Is it worth having one after taking into account the system’s cost, the financing interest, the reduced electricity costs, and the tax credit? We can assist you in conducting an objective analysis without pressure from a salesperson. Please call us before committing to purchase a solar electric system.

The IRS Has Become More Liberal With College Expenses

Computers and the Internet have become integral parts of education by providing access to online courses, learning and research. It is virtually impossible to be enrolled in postsecondary education without a computer, which is needed to complete written assignments, type reports, prepare theses and access the Internet.

Recent tax regulations have acknowledged the fact that computers, peripheral equipment, certain types of nonentertainment software, Internet access and related services are essential for postsecondary education. Thus, when those items are used primarily by a beneficiary of a qualified state tuition (Sec 529) plan, the cost of the items can be reimbursed from the plan’s funds, tax-free.

In addition, the regulations for the American Opportunity Tax Credit (AOTC) have been modified (effective in 2016) to clarify that the AOTC’s definition of qualified tuition and related expenses includes books, supplies and any other equipment that is required for enrollment or attendance at an eligible institution. For this purpose, the materials must be needed for “meaningful attendance or enrollment” in a course of study; they can be purchased from the institution or an outside vendor.

Computers are not specifically listed in the new AOTC regulations, but the wording certainly implies that a computer qualifies as long as it is required for meaningful attendance. This change is so new that there is no precedent for how the IRS will apply the regulations to computers, as the regulations do not specifically include them. To be on the safe side, each student seeking the credit should get an instructor to write a letter (on school letterhead) stating, “A computer is required for meaningful attendance.

For more information regarding which education expenses qualify for Sec 529 plan reimbursements or for the AOTC, please give this office a call.

Big Tax Break for Adoptive Parents

If you are an adoptive parent or are planning to adopt a child, you may qualify for a substantial income-tax credit. The amount of the credit is based on any expenses incurred that are directly related to the adoption of a child under the age of 18 or a person who is physically or mentally incapable of self-care.

This is a 1:1 credit for each dollar of qualified expenses up to a maximum for the year, which is $13,570 for 2017 (up from $13,460 in 2016). The credit is nonrefundable, which means it can only reduce tax liability to zero (as opposed to potentially resulting in a cash refund). But the good news is that any unused credit can be used for up to five years to reduce future tax liability.

Qualified expenses generally include adoption fees, court costs, attorney fees and travel expenses that are reasonable, necessary and directly related to the adoption of the child, and may be for both domestic and foreign adoptions; however, expenses related to adopting a spouse’s child are not eligible for this credit. When adopting a child with special needs, the full credit is allowed whether or not any qualified expenses were incurred. A child with special needs is, among other requirements, a child who the state has determined (a) cannot or should not be returned to his or her parents’ home and (b) that the child won’t be adopted unless assistance is provided to the adoptive parents.

The credit is phased out for higher-income taxpayers. For 2017, the AGI (computed without foreign-income exclusions) phase-out threshold is $203,540, and at the AGI of $243,540, the credit is completely phased out. Unlike most phase-outs, this one is the same regardless of filing status. However, the credit cannot be claimed by taxpayers using the filing status married filing separately.

If your employer has an adoption-assistance program, up to $13,570 of reimbursements by the employer are excludable from income. Both the tax credit and the exclusion may be claimed, though not for the same expenses.

If you think you qualify for this credit or are planning an adoption in the future, please contact this office for further credit details and to find out how this credit can apply to your particular circumstances.

Tax Benefits for Parents

If you are a parent, whether single, married or divorced, there are a significant number of tax benefits available to parents, including deductions, credits, filing status and exemptions that can help put a dent in your tax liability.

Exemptions – Regardless of filing status, you receive a $4,050 income exemption for each of your qualifying children whom you claim as a dependent on your tax return. In the case of divorced or separated parents, the exemption is allowed to the custodial parent unless the custodial parent releases the exemption to the non-custodial parent. If you are the custodial parent, you can release the exemption on a year-by-year basis or for multiple years if you wish to do so. However, being unable to foresee the future means it is generally wiser to release the exemption annually. The exemption amount gradually decreases to zero once a certain income threshold is reached; this phase out generally applies to higher income taxpayers.

Child Tax Credit – If you have dependent children, you are also entitled to a nonrefundable tax credit of $1,000 for each child under the age of 17 at the close of the year. The term “nonrefundable” means the credit can only be used to offset any tax liability you may have, and the balance of the credit is lost. If you are not filing jointly with the child’s other parent and have released the exemption to that parent, then you will not qualify for the child tax credit for that child. In addition, this credit also phases out for higher income taxpayers. For lower income parents, a portion of the child tax credit, which is normally nonrefundable, can become refundable.

Earned Income Tax Credit – The earned income credit benefits lower income parents based upon your earned income, filing status (either married filing jointly or unmarried) and the number of qualifying children you have up to three. The credit for 2017 can be as much as $6,318, and better yet, the amount not used to offset your tax liability is fully refundable. This credit is phased out for higher income filers, and those with investment income of more than $3,450 for 2017 aren’t eligible.

Head of Household Filing Status – The tax code provides a special filing status – head of household – for unmarried and separated taxpayers. The benefit of head of household filing status is that it provides lower tax rates and a higher standard deduction than the single status ($9,350 as opposed to $6,350 for a single individual in 2017). If you are an unmarried parent and you pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status. Even if you are married, if you lived apart from your spouse the last six months of the year and pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status.

Childcare – Many parents who work or are looking for work must arrange for care of their children. If this is your situation, and your children requiring care are under 13 years of age, you may qualify for a nonrefundable tax credit that can reduce your federal income taxes.

The childcare credit is an income-based percentage of up to $3,000 of qualifying care expenses for one child and up to $6,000 of qualifying care expenses for two or more children. The allowable expenses are also limited to your earned income, and if you are married, both you and your spouse must work and the limit is based upon the earned income of the spouse with the lower earnings. The credit percentages range from a maximum of 35% if your adjusted gross income (AGI) is $15,000 or less to 20% for an AGI of over $43,000.

If your employer provides dependent care benefits under a qualified plan that pays your child care provider either directly or by reimbursing you for the expenses, or your employer provides a day care facility, you may be able to exclude these benefits from your income. Of course, the same expenses aren’t eligible for both tax-free income and the child care credit.

Education Savings Plans – The tax code provides two plans to save for your children’s future education. The first is the Coverdell Education Savings Account, which allows non-deductible contributions of up to $2,000 per year. The earnings on these accounts are tax-free provided the amounts withdrawn from the accounts are used to pay qualified expenses for kindergarten and above. Coverdell contributions will phase out for higher income taxpayers beginning at an AGI of $190,000 for married taxpayers filing jointly and half that amount for other taxpayers.

A second plan, called a Qualified Tuition Plan (sometimes referred to as a Sec 529 plan), allows individuals to gift large sums of money for a family member’s college education while continuing to maintain control of the funds. The earnings from these accounts grow tax-deferred and are tax-free if used to pay for college tuition and related expenses.

Contributions to these plans are not limited to the child’s parents and can be made by virtually anyone, although if not the parents, then typically it is the grandparents who fund the accounts.

Education Credits – If you are a parent with a child or children in college, don’t overlook the American Opportunity Tax Credit (AOTC). It provides a tax credit equal to 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000 for each child who was enrolled at least half time. Better yet, 40% of the credit is refundable. This credit is good for the first four years of post-secondary education.

There is a second education credit called the Lifetime Learning Credit (LLC) that provides a nonrefundable tax credit equal to 20% of up to $10,000 of qualified tuition and related expenses. Unlike the AOTC, which is allowed per student, the LLC is calculated on a per-family basis with a maximum credit of $2,000 but is not limited to the first four years of post-secondary education.

You don’t even have to pay the expenses to get the credits. The credits are allowed to the person claiming the exemption for the child. So if the child’s grandparent, uncle, aunt or even an ex-spouse or the child’s other parent pays the tuition, you still get the credit as long you claim the child as your dependent.

Student Loan Interest – Generally, personal interest you pay, other than certain mortgage interest, isn’t deductible on your tax return. However, there is a special deduction, up to $2,500 per year, allowed for interest paid on a student loan (also known as an education loan) used for higher education. You don’t have to itemize deductions to take advantage of this deduction, but you must have paid the interest on a loan taken out for your own or your spouse’s education or that of a dependent. So if you were legally obligated to pay the loan for one of your children who was your dependent when the loan was taken out, you may be able to claim this deduction, even if the child is no longer your dependent.

The student must have been enrolled at least half-time, and the loan must have been taken out solely to pay qualified higher education expenses. The lender can’t be a related person. This deduction phases out if your AGI is more than $65,000 ($130,000 if filing a joint return) and isn’t allowed if you use the married filing separate status.

Child’s Medical Expenses – If you itemize deductions, the unreimbursed medical expenses you pay for your dependents are counted for figuring your total medical expenses. This is true for both parents even if they do not file together as long as one of them is able to claim the child as a dependent.

If you have questions related to any of these tax benefits, please give this office a call.

Don’t Miss out on the Electric Vehicle Credit

If you are considering purchasing a new car or light truck (less than 14,000 pounds), maybe you should consider one of the many electric vehicles currently being offered for sale and take advantage of a federal income tax credit worth as much as $7,500.

The tax credit is actually made up of two parts: the basic amount of $2,500, which requires the electric vehicle to have a battery with at least 5 kilowatt-hours of capacity, and an additional $417 of credit for each kilowatt-hour of battery capacity in excess of 5 kilowatt-hours. The total amount of the credit allowed for any qualified vehicle is limited to $7,500.

However, the credit begins to be phased out for a particular manufacturer’s vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States.

If you are not an electrical engineer, it may seem a little complicated to figure out which vehicles qualify for the credit and for how much. You can usually rely on the information provided by the dealer. However, to be on the safe side, you can verify which vehicles are qualified and the credit amount available, based on the vehicle’s kilowatt-hours and the reduction in credit due to the credit phaseout, by visiting the IRS website. From the list on the linked page, click on the manufacturer of the vehicle you are interested in to find out if the model and year of that vehicle qualify for the credit and the amount of the credit.

To be eligible for the credit, you must acquire the vehicle for use or lease and not for resale. Additionally, the original use of the vehicle must commence with you, and you must use the vehicle predominantly in the United States. The vehicle is not considered acquired prior to the time when its title passes to you under your state’s law. The credit is available whether you use the vehicle for business, personally or a combination of both. The prorated portion of the credit that applies to business use becomes part of the general business credit, and any amount not used on your return for the year when you purchase the vehicle can be carried back to the previous year and then carried forward until used up, but for no more than 20 years.

What a Dealer May Not Tell You – The portion of the credit that is not treated as a general business credit (i.e., the personal use portion of the credit) is non-refundable. That means it can only be used to offset your tax liability for the year when you purchase the vehicle, and any excess credit is lost. Assuming you purchase the vehicle in 2016 and your 2016 tax return will be similar to your 2015 return, you can get an idea of how the credit will apply to you by comparing the amount on line 47 of your 2015 Form 1040 to the credit the vehicle provides. If line 47 is greater than the credit, then you will probably benefit from the entire amount of the credit on your 2016 return. If it is less, then you will only benefit from the amount on line 47 as it will be figured for your 2016 return.

If your 2016 tax return will be significantly different from your 2015 return, or you simply want to verify your benefit from the credit, please give this office a call.

Back to School? Tax Breaks May Help to Pay the Cost!

Now that summer is over, it is time for many young adults to head back to college or university, and time for their parents or family members to dig into their pockets to help pay for that schooling. Paying for education can be financially challenging for many families. However, tuition and related expenses paid for higher education can qualify for one of two education tax credits. These credits will lower the income tax burden for the individual who claims the exemption for the student. For example, if the student were claimed as a dependent on the parents’ return, the parents would claim the credit, but if the student filed independently, he or she would get the credit. This is true regardless of who actually pays the tuition and related expenses.

American Opportunity Tax Credit (AOTC) – The AOTC provides a credit of up to $2,500 per year per eligible student. Generally, tax credits are non-refundable, meaning they can only be used to offset any tax liability the taxpayer may have for the year. However, up to 40% of the AOTC is refundable, even when the taxpayer has no tax liability. Thus, it can result in a refund of as much as $1,000 (40% of $2,500).

The credit is for 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of qualifying expenses. However, the AOTC is only allowed for four years of post-secondary education. It is also determined on a per student basis and phases out for higher-income taxpayers. The student must be enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period beginning in the tax year of the credit.

Lifetime Learning Credit (LLC) ‒ The LLC is a non-refundable credit worth up to $2,000 per year, and there is no limit on the number of years that the LLC can be claimed. Unlike the AOTC, there is no “half-time student” requirement, and single courses can qualify. The credit is 20% of the cost of tuition and related expenses. However, while the AOTC is determined on a per student basis, the LLC is based upon the tax family’s qualified education expenses for the year. Where a student qualifies for the more beneficial AOTC, that student’s expenses cannot be used for the LLC.

There are additional requirements that apply to both credits:

  • Qualified expenses ‒ include the costs you pay for tuition, fees, and other related expenses for an eligible student to enroll at or attend an eligible educational institution.
  • Eligible educational institutions ‒  generally include any accredited public, nonprofit, or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This includes most colleges and universities. Vocational schools or other post-secondary schools may also qualify. If you aren’t sure if the student’s school is eligible, ask the school if it is an eligible educational institution.
  • Form 1098-T ‒ In most cases, you (or the student) should receive Form 1098-T, Tuition Statement, from the school reporting the qualifying expenses to the IRS and to you. The amount shown on the form may be either (1) the amount you paid to the school for qualifying tuition and related expenses, or (2) the amount billed by the school for qualifying tuition and related expenses. Therefore, the amount shown on the form may be different from the amount eligible for the credit. Don’t forget that you can only claim an education credit for the qualifying tuition and related expenses that you paid in the tax year and not just the amount the school billed. There is a provision that allows the tuition for the first three months of the next year to be prepaid and deducted on the tax return for the year of payment. However, prepaid tuition cannot be deducted in the subsequent year.

There are other education tax benefits available as well, such as the education loan interest deduction and savings bond interest exclusion. If you are reading this article so you can plan for the future, there are also tax-advantage education savings plans available – the Coverdell and Sec 529 plans.

If you would like to learn how the education tax credits or other benefits might apply to your particular circumstances, please give this office a call.