Education tax credits
american opportunity and Lifetime LearNing Credits
The American opportunity credit allows taxpayers to claim a credit of up to $2500 for qualified education expenses paid for each eligible student. A tax credit reduces the amount of income tax the taxpayer may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. Forty percent of the American opportunity credit may be refundable. The allowable American opportunity credit may be limited by the amount of the taxpayer's income. The refundable part of the credit may be limited by the amount of the taxpayer's tax. It is available for the only for the first 4 years of postsecondary education and only for 4 tax years per eligible student (including any years the HOPE credit was claimed). The student must be enrolled on at least a half-time basis for at least one academic period during the year for the expenses to be qualified and must be pursuing an undergraduate degree or other recognized education credential. An eligible student is either the taxpayer, taxpayer's spouse, or a dependent who is claimed as an exemption on the taxpayer's tax return.
The lifetime learning credit allows taxpayers to claim a maximum credit up to $2,000 per tax return incurred during the taxable year for qualified tuition and fees for eligible students for post-secondary education, including any course of instruction to acquire or improve job skills. There is no limit on the number of years the lifetime learning credit can be claimed for each student. The lifetime learning credit may be limited by the amount of the taxpayer's income and is a nonrefundable credit.
Both credits limit qualified expenses to the expenses of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer. Additionally, the total of qualified expenses must be reduced by any tax-free educational assistance (grants, scholarships, employer-provided tuition assistance) and by any refunds of qualified expenses. Qualified expenses paid for with loans are eligible. For each qualifying student, taxpayers must choose to claim either the American opportunity credit, the lifetime learning credit, or the exclusion for certain distributions from an education savings account for the taxable year.
To claim the credits, taxpayers are required to provide the name and taxpayer identification number of the student on the return. Educational institutions are required to report information related to higher education tuition and related expenses assessed during the taxable year.
Coverdell Education Savings Account
Taxpayers whose modified adjusted gross income is less than $110,000 for single filers and $220,000 for joint filers may establish a Coverdell Education Savings Account to finance the qualified education expenses of a designated beneficiary. Qualified education expenses include tuition, fees, books, supplies and equipment, and room and board. Contributions are non-deductible, and earnings on the amount held in the Coverdell ESA will be non-taxable until distributed. Annual contributions are limited to $2,000 per beneficiary under the age of 18.
Distributions from a Coverdell ESA are excludable from income to the extent the amount does not exceed the qualified education expenses of the eligible student during the year. If the distribution from the Coverdell ESA exceeds the qualified education expenses, only a portion of the distribution is excludable. In addition, distributions not used for education are subject to a 10 percent addition to tax. Any balance remaining in a Coverdell ESA at the time a beneficiary becomes 30 years of age is to be distributed and taxed to the beneficiary (and subject to the 10 percent addition to tax). However, the balance may be rolled over tax free to another Coverdell ESA benefiting another family member.
"Above-the-line" deduction for qualified higher education expenses
The taxpayer may deduct qualified education expenses paid during the year for the taxpayer, taxpayer's spouse, or taxpayer's dependents and may be limited by the amount of the taxpayer's income. Married taxpayers must file jointly to take the deduction, and the credit may not be claimed on the return of anyone who is claimed as a dependent on another person's return. The qualified higher education expenses are defined in the same manner as for the American opportunity credit. Taxpayers may claim the American opportunity/lifetime learning credit or the "above-the-line" deduction, but not both.
Deduction for interest on education loans
The deduction for interest on education loans is an above-the-line maximum deduction for up to $2,500 of interest paid by taxpayers on qualified education loans. The amount of the deduction may be limited by the amount of the taxpayer's income. Taxpayers may take a deduction on qualified education loans for the benefit of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred. Married taxpayers must file jointly to take the deduction, and the credit may not be claimed on the return of anyone who is claimed as a dependent on another person's return.