Education Credits

Two tax credits are available for education costs ? the Hope credit and the lifetime-learning credit. These credits are available only to taxpayers with adjusted gross income below specified amounts, see Income Phase-Outs, below.

How These Credits Work

The amount of the credit you can claim depends on (1) how much you pay for qualified tuition and other expenses for students and (2) your adjusted gross income (AGI) for the year.

You must report the eligible student?s name and Social Security number on your return to claim the credit. You subtract the credits from your federal income tax. If the credit reduces your tax below zero, you cannot receive the excess as a refund. If you receive a refund of education costs for which you claimed a credit in a later year, you may have to repay ("recapture") the credit.

Caution: If you file married-filing separately, you cannot claim these credits.

Which costs are eligible. Qualified expenses, include tuition and fees required for enrollment or attendance at an eligible education institution and course materials. They do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.

Tip: If you pay qualified expenses for a school semester that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit.

Example: You pay $1,500 of tuition in December 2008 for the winter 2009 semester, which begins in January 2009. You can use the $1,500 in figuring your 2008 credit. If you paid in January instead, you would take the credit on your 2009 return.

Tip: As future year-end tax planning, this rule gives you a choice of the year to take the credit for academic periods beginning in the first 3 months of the year; pay by December and take the credit this year; pay in January or later and take the credit next year.

Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another's dependent can't claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit, or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.

No "double-dipping." The tax law says that you can't claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.

Income Phase-outs. Your education credits are gradually phased out if your modified AGI for 2009 is between $80,000 and $90,000 ($160,000 and $180,000 for joint returns). These income phaseout limits for 2009 were siginficantly increased under the American Recovery and Reinvestment Act of 2009. The 2008 limits were between $48,000-58,000 for single taxpayers and $96,000-116,000 for joint fliers. Once your modified AGI reaches the top limit of these ranges, you cannot claim any education credit. "Modified AGI" generally means your adjusted gross income. The "modifications" only come into play if you have income earned abroad.

The Hope Credit

Under the American Recovery and Reinvestment Act of 2009, the maximum Hope credit, which is available for the first four years of post secondary education, increases to $2,500 in 2009 and 2010. You can claim the Hope credit for each eligible student you have for which the Hope credit requirements are met. The credit can now be claimed for four years per eligible student. (In 2008, the Hope Credit was a maximum of $1,800 and allowable for the only the first two years of post secondary education.)

Special qualification rules. In addition to being an eligible student, he or she:

• Must be enrolled in post secondary education;
• Must be enrolled in a program leading to a degree, certificate, or other recognized credential;
• Must be taking at least half of a normal full-time load of courses, for at least one semester or trimester beginning in the year for which the credit is claimed; and
• May not have any drug-related felony convictions.

Amount of credit. The amount of the Hope credit in 2009 is 100% of first $2,000 of qualified tuition and related expenses paid by the taxpayer during the taxable year, plus 25% of the next $2,000 paid, reaching the maximum credit of $2,500. In 2008, the calculation was as follows: 100% of the first $1,200 plus 50% of the next $1,200 you pay for each eligible student or a maximum total of $1,800. These amounts are indexed for inflation. The maximum you can claim in 2009 and 2010 is $2,500 times the number of eligible students. Thus, you will benefit from the maximum $2,500 amount for each eligible student for whom you pay at least $4,000. Remember, however, that the credit may be reduced based on your AGI. The Hope credit is phased out with modified adjusted gross incomes between $80,000 and $90,000 for single filers and $160,000 to $180,000 for joint filers in 2009. Credit is not allowed for married filing separately.

The Lifetime Learning Credit

You may be able to claim a Lifetime Learning credit of up to $2,000 (20% of the first $10,000 of qualified expense) for eligible students (subject to reduction based on your AGI). Only one Lifetime Learning Credit can be taken per tax return, regardless of the number of students in the family. The eligibility rules for the Lifetime Learning credit are broader than those that apply to the Hope credit:

• Unlike the Hope credit, students need not be in the first two years of undergraduate education; all undergraduate and graduate programs qualify.
• Further, for courses taken to acquire or improve job skills, there are no requirements as to course loads, so that even one or two courses can qualify.
• The number of years for which this credit can be claimed is not limited.

Choosing the Credit. You can't claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year ? for example, a Hope credit for your child and a lifetime learning credit for yourself.

Electing Not To Take the Credit. There are situations in which the credit is not allowed, or not fully available, if some other education tax benefit is claimed ? where the higher education expense deduction is claimed for the same student, see below, or where credit and tax exemption (under a Section 529 or 530 program) are claimed for the same expense. In that case the taxpayer ? or, more likely, the taxpayer?s tax adviser ? will determine which tax rule offers the greater benefit and if it?s not the credit, elect not to take the credit.

 Qualified Tuition and Related Expenses Deduction

A limited deduction is allowed for "qualified higher education expenses" ? tuition and related expenses under the same definition as for tuition credits, above. Business deduction is allowed already, without dollar limit, for education that serves the taxpayer?s business, including employment. The Qualified Higher Education Tuition Deduction extends to expenses having no business connection, which is the usual case with higher education expenses. Where the taxpayer claims another education-related deduction, such as a business or interest deduction, this deduction can?t be claimed for the same items.

The law doesn?t prescribe who the expense must be paid for ? self, dependent, etc. ? but it precludes deduction for one who is another?s dependent or who is married filing separately. And it can?t be claimed where a tuition credit is claimed (by anyone) for the same student.

For 2009 and 2008, a deduction up to $4,000 is allowed if taxpayer?s (modified) adjusted gross income (AGI) is $65,000 or less ($130,000 or less on a joint return). Deduction up to $2,000 is allowed taxpayers with AGI between $65,000?$80,000 ($190,000 ? $220,000 on a joint return).

"Qualified higher education expenses" must be reduced by any such expense paid with an amount treated as tax-free under the rules for excluding income from Series EE bonds, or Section 529 or 530 programs.

The deduction is above the line ? meaning it?s not subject to the 2% floor on itemized deductions and is allowed whether or not the standard deduction is claimed.

 Employer-Provided Education Assistance

If your employer paid education assistance benefits (e.g., reimbursements of tuition), part or all of them may be tax-free. You can exclude up to $5,250 per year of the benefits you receive under a qualified education assistance program. But you can't both exclude and deduct the same item, even if it's otherwise deductible. In order to qualify your employer must have established an educational assistance plan that does not discriminate in favor of highly paid employees or owners. The exclusion applies to undergraduate level courses other than those involving sports, game and hobbies. The courses do not need to relate to your job. The exclusion is available for tuition, fees, books and supplies but not meals, lodging or transportation. And it applies to benefits for graduate level courses.

In addition to the exclusion for qualifying education plans, your employer can provide reimbursement for business related courses, including graduate courses. If your employer does not reimburse you for these expenses, you may be entitled to deduct them as a miscellaneous itemized deduction subject to the 2% deduction floor. To qualify, the expense must meet the requirement of your employer or the law or maintain or improve skills in your current job. The course must not meet minimum education requirements for your job or qualify you for a new trade or business.

 Student Loans

You may be able to deduct interest on student loans. You may also be able to exclude income that you would otherwise have to report if a student loan is cancelled.

Interest Deduction. You may deduct student loan interest you pay, including interest paid that?s not currently due because payment is deferred.

Deduction is allowed even though it would otherwise be nondeductible personal interest. But you may deduct only if you are the one legally bound to pay the interest, and only on loans solely for qualified expenses (so not under open credit lines).

The student-loan deduction up to $2,500 is available in 2009 only to taxpayers whose AGI is below $150,000 (joint amount) or $75,000 (single amount). Married couples filing separately can't deduct. The deduction is phased out for those whose AGI is above $120,000 (joint amount) or $69,000 (single amount). The dollar amounts are indexed for inflation; these are the amounts for 2009. (For 2008, the respective AGI amounts for the phase out were $115,000-$145,000 (joint) and $55,000-70,000 (single).

The student-loan interest deduction is an "above the line" deduction ? you don?t have to itemize to claim it. The loan must have been taken out to cover education expenses of at least half-time study for yourself, your spouse, or a person who was your dependent when you took out the loan. The maximum deduction is $2,500.

Caution:You cannot deduct interest on a loan from a related person ? e.g. a relative, or a business entity in which you have an ownership interest as defined by the tax law. And you can't deduct if you are claimed as a dependent.

Tip: Where interest fails to qualify under these tests, consider a home equity loan, interest on which is generally deductible.

Cancellation of Student Loan. If certain requirements are met, cancellations of student loans that are intended to induce students to perform certain services do not increase the student?s gross income. This relief extends to certain private programs, as well as government and public programs.