Higher education costs are rising fast. But you could be able to turn part of the expenses you pay for yourself, your spouse or dependents into tax savings. You can do this by claiming the American Opportunity tax credit or Lifetime Learning credit for tuition and related expenses.
The maximum American Opportunity tax credit you can claim is $2,500 per student for the first four years of undergraduate education at an eligible educational institution. The credit is 100 percent of the first $2,000 of qualifying expenses and 25 percent of the next $2,000. So the maximum credit of $2,500 is reached when a student has qualifying expenses of $4,000 or more. Since the limit is per student and not per taxpayer, if you incur qualifying expenses for yourself and two children, for example, your credit could reach as high as $7,500.
The maximum Lifetime Learning credit is $2,000 per year per taxpayer — 20 percent of up to $10,000 of expenses for any post-high school education, including graduate-level courses and courses to acquire or improve job skills at an eligible educational institution. In general, accredited schools offering credit towards associate’s or bachelor’s degrees are eligible educational institutions. There’s no limit on the number of years for which the Lifetime Learning credit may be claimed.
The American Opportunity tax credit is available only for the qualified tuition and related expenses of an eligible student. This is a student who’s enrolled at least half time in a degree or certificate program at an eligible educational institution and has never been convicted of a state or federal felony drug offense. The Lifetime Learning credit isn’t subject to the eligible student or felony drug offense restrictions and may be available for a student who’s attending school less than half-time.
Both credits are claimed in the tax year the expenses are paid if the education begins during that year or during the first three months of the next year. Under this rule, taxpayers have a timing option since the credit will be available in the year the payment is made.
For example, in 2013 a taxpayer pays qualified tuition and related expenses to the college for the second semester of a freshman year that begins in January 2014. The taxpayer will use the payment to claim the credit on a 2013 tax return because the education begins during the first three months of the following year. However, if the taxpayer paid the expenses in January of 2014, they must claim the credit in 2014. This timing option allows the taxpayer to choose the year a credit is claimed. If the taxpayer has already paid $4,000 or more of qualified educational expenses in the current year, maximizing the American Opportunity Tax Credit, he or she might consider delaying payment until the following year.
The Lifetime Learning credit is nonrefundable. It can reduce regular income taxes to zero, but can’t result in a refund. The American Opportunity tax credit, on the other hand, is 40 percent refundable under certain circumstances. This means you can receive a refund if the amount of the credit is greater than your tax liability. Consider, for example, a taxpayer who isn’t eligible to be claimed as a dependent on another’s return and has at least $4,000 in qualified expenses in qualifying for the maximum credit of $2,500, but has no tax liability to offset that credit against. That taxpayer would qualify for a $1,000 refund — 40 percent of $2,500.
It’s important to note the amount of qualified tuition and related expenses used to calculate these credits must be reduced by tax-exempt scholarships and fellowships, certain military benefits and any other tax-exempt payments of those expenses other than gifts or bequests. If the expenses upon which the credit is based are later refunded, the credit could have to be recaptured. The tax for the refund year could be increased to account for a recomputed credit for the earlier year.
Both the American Opportunity and Lifetime Learning tax credits are phased out for higher-income taxpayers. The American Opportunity tax credit is phased out for couples with income between $160,000 and $180,000 or single individuals with income between $80,000 and $90,000. The Lifetime Learning credit for 2013 is phased out for couples with income between $107,000 and $127,000 or single individuals with income between $53,000 and $63,000. The phase-out range for the Lifetime Learning credit is adjusted annually for inflation. Neither credit is available for taxpayers who’re married and filing separately.
To learn more about these credits and how they could provide a tax savings to you, consult with a qualified professional to review your specific circumstances and determine if your situation is eligible for the American Opportunity or Lifetime Learning tax credits.