If you paid eligible higher education expenses during the year for yourself, your spouse, or a dependent on your tax return, you may be able to claim a credit, deduction, or some other benefit on your income tax return. The main objective of this chapter to bring to your awareness all the education credits, deductions, and benefits, which you might be eligible for; to enlighten you how to claim these benefits, and to enable you to make an informed decision, based on your particular circumstances, as to which ones would be more beneficial.
Education Credits
There are two types of education credits:
• The American Opportunity Credit. Part of this credit is nonrefundable (60%) and part is refundable (40%).
• The Lifetime Learning Credit, which is a nonrefundable credit.
• The Lifetime Learning Credit, which is a nonrefundable credit.
Any amounts you pay for higher education are reported to you and the IRS on Form 1098-T by the educational institution. You claim education credits on both line 49 (the nonrefundable amount) and line 66 (the refundable amount) of Form 1040.
To be eligible to claim an education credit, you must have paid qualified expenses for an eligible student to an eligible educational institution. These terms are defined below:
• Qualified expenses are tuition and fees you are required to pay to the educational institution as a condition of enrollment or attendance.
• An eligible student must be enrolled at an eligible educational institution for at least one academic period during the year. An academic period can be a semester, quarter, or summer session.
• An eligible educational institution is any college, university, or vocational school eligible to participate in a student aid program administered by the United States Department of Education.
• An eligible student must be enrolled at an eligible educational institution for at least one academic period during the year. An academic period can be a semester, quarter, or summer session.
• An eligible educational institution is any college, university, or vocational school eligible to participate in a student aid program administered by the United States Department of Education.
To claim an education credit, the following rules apply:
• The expenses must be for an academic period that begins in the same year you paid the expenses, or for an academic period that begins in the first three months of the year following the year of payment.
• The expenses can be paid with the proceeds of loans, gifts, or inheritances.
• You cannot claim an education credit if your filing status is MFS.
• The amount of the credit is reduced and eventually eliminated as your income increases, depending on your modified adjusted gross income and your filing status.
• You cannot take the credit if you can be claimed, and are claimed as a dependent on another person's tax return.
• You can claim the credit for any qualified expenses paid by a dependent that you claim of your tax return.
• A student, whose exemption is not claim by the person eligible to claim it, can claim the education credit for qualified expenses. However, on the student's tax return, he/she is not eligible to claim his/her own exemption-only the education credit. (Tax law states that you cannot claim your own exemption if you can be claimed by another person, even though that person did not claim you.)
• The expenses can be paid with the proceeds of loans, gifts, or inheritances.
• You cannot claim an education credit if your filing status is MFS.
• The amount of the credit is reduced and eventually eliminated as your income increases, depending on your modified adjusted gross income and your filing status.
• You cannot take the credit if you can be claimed, and are claimed as a dependent on another person's tax return.
• You can claim the credit for any qualified expenses paid by a dependent that you claim of your tax return.
• A student, whose exemption is not claim by the person eligible to claim it, can claim the education credit for qualified expenses. However, on the student's tax return, he/she is not eligible to claim his/her own exemption-only the education credit. (Tax law states that you cannot claim your own exemption if you can be claimed by another person, even though that person did not claim you.)
In any one year, only one person can claim the higher education credit for a student's expenses. If you pay higher education costs for a dependent child, either you or the child, but not both, can claim the credit for a particular year. If you claim an exemption for the child, only you can claim the credit, also, any expenses paid by the child are treated as paid by you when figuring the amount of the American opportunity or lifetime learning credit.
The American Opportunity Credit
You can claim this credit for yourself, your spouse, or any dependent on your tax return.
The American opportunity credit can be claimed ONLY for the first four years of post secondary education for each eligible student. This means that this credit is applicable only to students who are in their freshman, sophomore, junior, and senior years.
To be eligible to claim the American opportunity credit, the following conditions must apply:
• The student must be enrolled in a program that leads to a degree or other recognized educational credential. This means enrollment in an accredited college, university, vocational school, or other accredited postsecondary educational institution.
• The student must be taking at least half the full-time workload for the course of study for at least one academic period during the calendar year.
• The student must not have been convicted of a felony for possessing or distributing a controlled substance.
• The student must be taking at least half the full-time workload for the course of study for at least one academic period during the calendar year.
• The student must not have been convicted of a felony for possessing or distributing a controlled substance.
For purposes of the American opportunity credit, qualified education expenses include:
• Tuition and certain related expenses required for enrollment or attendance at the eligible educational institution.
• Expenses for books, supplies, and equipment needed for a course of study, whether or not the materials are purchased from the educational institution. (For example, the expenditure for purchasing a computer could qualify for the credit if the computer is needed as a condition of enrollment or attendance at the educational institution.)
• Expenses for books, supplies, and equipment needed for a course of study, whether or not the materials are purchased from the educational institution. (For example, the expenditure for purchasing a computer could qualify for the credit if the computer is needed as a condition of enrollment or attendance at the educational institution.)
The following expenses do not qualify for the credit:
• Room and board.
• Transportation.
• Insurance.
• Medical expenses.
• Student fees, except they are a condition of enrollment or attendance.
• Expenses paid with non-taxable funds or tax-free educational assistance.
• The same expenses used for any other tax deduction, credit or educational benefit.
• Transportation.
• Insurance.
• Medical expenses.
• Student fees, except they are a condition of enrollment or attendance.
• Expenses paid with non-taxable funds or tax-free educational assistance.
• The same expenses used for any other tax deduction, credit or educational benefit.
To qualify for the credit, the expenses must be paid for an academic period beginning during the year, or in the first three months of the following year.
The amount of the credit is 100% of the first $2,000 plus 25% of the next $2,000 paid for each eligible student's qualified tuition and related expenses. Therefore the maximum credit is $2,500 per eligible student. Your total credit for the year, then, can be up to $2,500 multiplied by the number of eligible students that you claim on your tax return.
The American opportunity credit is partially nonrefundable and partially refundable. You claim the nonrefundable portion on line 49 of Form 1040, and the refundable portion on line 66 of Form 1040. In essence then, you will be able to reduce your tax liability one dollar for each dollar of the credit for which you are eligible. If the amount of the credit is more than your tax liability, the amount that exceeds your tax liability is refundable to you, up to a maximum of 40 percent of the credit for which you are eligible (that is, up to a maximum of $1,000).
The American opportunity credit is reduced ratably if your modified AGI exceeds $80,000 ($160,000 if filing a joint return). If your modified AGI is greater than $90,000 ($180,000 if filing jointly) you cannot benefit from this credit.
The Lifetime Learning Credit
You can claim the lifetime learning credit for qualified tuition and related expenses paid for yourself, your spouse, and any dependent on your return who is enrolled at any accredited college, university, vocational school, or other accredited postsecondary educational institution. As its name implies, there is no limit for the number of years for which the lifetime learning credit can be claimed for each student.
Unlike the American opportunity credit:
• The lifetime learning credit is not based on the student's workload. It is allowed for one or more courses.
• The lifetime learning credit is not limited to students in the first four years of postsecondary education; therefore expenses for graduate-level degree courses are eligible.
• Felony drug convictions are permitted.
• Expenses for course-related books, supplies, and equipment are qualified education expenses ONLY if paid to the institution, as a condition of enrollment or attendance.
• The lifetime learning credit is a nonrefundable credit. This means that it can reduce your tax to zero, but if the credit is more than your tax, the excess will not be refunded to you.
• The lifetime learning credit is not based on the student's workload. It is allowed for one or more courses.
• The lifetime learning credit is not limited to students in the first four years of postsecondary education; therefore expenses for graduate-level degree courses are eligible.
• Felony drug convictions are permitted.
• Expenses for course-related books, supplies, and equipment are qualified education expenses ONLY if paid to the institution, as a condition of enrollment or attendance.
• The lifetime learning credit is a nonrefundable credit. This means that it can reduce your tax to zero, but if the credit is more than your tax, the excess will not be refunded to you.
To be eligible to claim this credit, your expenses must be for courses taken as part of a postsecondary degree program, or to improve or acquire job skills.
The amount of the credit is 20% of the first $10,000 of qualified tuition and related expenses paid for ALL eligible students on your tax return. This means then, that the maximum credit that can be claimed on a tax return is $2,000.
To be eligible to claim the lifetime learning credit, your modified AGI must be less than $61,000 ($122,000 if filing jointly).
Claiming the education credits
You claim both the American opportunity credit and the lifetime learning credit by completing Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits) as follows:
• The American opportunity credit is figured in Part 1.
• The lifetime learning credit is figured in Part II.
• Completed Part III to determine the refundable amount of the American opportunity credit. You enter this amount on line 66 of Form 1040.
• Complete Part IV to determine the nonrefundable amount of the American opportunity credit. You enter this amount on line 49 of Form 1040.
• You must include Form 8863 with your return.
• The American opportunity credit is figured in Part 1.
• The lifetime learning credit is figured in Part II.
• Completed Part III to determine the refundable amount of the American opportunity credit. You enter this amount on line 66 of Form 1040.
• Complete Part IV to determine the nonrefundable amount of the American opportunity credit. You enter this amount on line 49 of Form 1040.
• You must include Form 8863 with your return.
Other points to consider
• In any tax year, you can receive only one tax benefit for each student. Therefore, if you choose to claim the American opportunity credit for a student, you cannot also include that student's expenses in figuring the lifetime learning credit for the year.
• If you pay qualifying expenses for more than one student, you can choose to take credits on a per-student, per-year basis. This means that you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year, depending on your particular circumstances.
• If you claim either the American opportunity credit or the lifetime learning credit, you cannot take the tuition and fees deduction (see below) for the same expenses.
Student Loan Interest Deduction
You may be able to take a deduction for interest you pay on a qualified student loan. Generally, the amount you may deduct is the lesser of: (a) $2,500, or (b) the amount of interest you actually paid. You claim the student loan interest deduction as an adjustment to income on line 33 of Form 1040.
To be eligible for the student loan interest deduction, the following conditions must apply:
• You paid interest on a qualified student loan in tax year 2011.
• You are legally obligated to pay interest on a qualified student loan.
• Your filing status is not Married Filing Separately.
• The loan must be for you, your spouse, or a dependent on your tax return at the time you took the loan.
• The loan must be used only for qualified education expenses. These are: tuition, fees, room and board, and any other necessary expenses paid to an eligible educational institution.
• The qualified expenses must be paid within a reasonable period of time before or after you took the loan.
• The loan cannot be from a related person, or made under a qualified employer plan.
• You (and your spouse, if filing jointly) cannot be claimed as dependents on someone else's tax return.
• You are legally obligated to pay interest on a qualified student loan.
• Your filing status is not Married Filing Separately.
• The loan must be for you, your spouse, or a dependent on your tax return at the time you took the loan.
• The loan must be used only for qualified education expenses. These are: tuition, fees, room and board, and any other necessary expenses paid to an eligible educational institution.
• The qualified expenses must be paid within a reasonable period of time before or after you took the loan.
• The loan cannot be from a related person, or made under a qualified employer plan.
• You (and your spouse, if filing jointly) cannot be claimed as dependents on someone else's tax return.
If you paid interest of $600 or more on a qualified student loan during the year, you should receive a Form 1098-E, Student Loan Interest Statement, from the entity to which you paid the student loan interest.
A qualified student loan is an amount you borrowed to pay for qualified education expenses, at an eligible educational institution, for an eligible student. An eligible educational institution includes most institutions of higher learning.
To be considered an eligible student, you, your spouse, or your dependent must be enrolled in at least half the normal full-time workload in a program leading to a recognized educational credential (graduate or undergraduate).
If you received any nontaxable education benefits, you must reduce your education expenses by these amounts.
The student loan interest deduction is phased out if your modified AGI is between $60,000 and $75,000 ($120,000 and $150,000 if filing a joint return).
(Off-the-shelf tax software will effectively calculate the deductible portion of your student loan interest, or you can use the worksheet found in Publication 970.)
Tuition and Fees Deduction
If you paid qualified tuition and related expenses for yourself, your spouse, or a dependent on your tax return, you may be able to take a deduction for tuition and fees, instead of the education credits. The maximum amount of the deduction you can claim is $4,000 per year. To claim the tuition and fees deduction, you must complete Form 8917, Tuition and Fees Deduction, and attach it to Form 1040. You claim this deduction on line 34 of Form 1040.
To be eligible for this deduction, you, your spouse, or dependent(s) must have paid qualified tuition and fees to an eligible educational institution.
Qualified tuition and fees do not include any of the following:
• Amounts you paid for room and board, medical transportation, or similar personal or family expenses.
• Amounts you paid for course-related books, supplies, equipment and nonacademic activities, unless these amounts were paid to the institution as a condition of enrollment or attendance.
• Amounts you paid for sports, games, etc., unless they are a part of the student's degree program.
• Amounts you paid for course-related books, supplies, equipment and nonacademic activities, unless these amounts were paid to the institution as a condition of enrollment or attendance.
• Amounts you paid for sports, games, etc., unless they are a part of the student's degree program.
You cannot take the tuition and fees deduction if any of the following apply:
• Your filing status is MFS.
• You can be claimed as a dependent on another person's tax return.
• Your modified AGI is more than $80,000 ($160,000 if filing MFJ).
• You were a nonresident alien for any part of the year, and did not elect to be treated as a resident alien for tax purposes.
• You are claiming the American opportunity or lifetime learning credit for the same student.
• You can be claimed as a dependent on another person's tax return.
• Your modified AGI is more than $80,000 ($160,000 if filing MFJ).
• You were a nonresident alien for any part of the year, and did not elect to be treated as a resident alien for tax purposes.
• You are claiming the American opportunity or lifetime learning credit for the same student.
Also, you cannot claim a deduction or credit based on expenses paid with the following: (a) a tax-free scholarship, fellowship, grant, or education savings account funds such as a Coverdell education savings account, (b) tax-free savings bond interest, or (c) employer-provided education assistance.
Before finalizing your tax return, it probably would be wise to first prepare two tax returns; claiming the education credit on one, and claiming the tuition and fees deduction on the other, then compare the results of both, and choose the one that gives the greater tax advantage. This exercise would be particularly useful especially if your income is close to the phase out level for the education credit you are planning to claim.
Coverdell Education Savings Account (ESA)
A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses. It is a trust or custodial account created in the U.S. for the purpose of paying the qualified higher education expenses of the beneficiary (child) under the age of 18. The contribution is limited to $2,000 for each beneficiary; it is not tax deductible, but amounts deposited in the account can grow tax-free until distributed.
If distributions from a Coverdell ESA exceed qualified education expenses, the excess distribution will be taxable to the beneficiary, and will usually be subject to an addition 10% tax. There are exceptions to the 10% addition tax rule, which include the death or disability of the beneficiary, or if the beneficiary receives a qualified scholarship.
Qualified education expenses include tuition, books, supplies, and room and board.
There are contribution limits to a Coverdell ESA based on your modified AGI. Your contribution to an ESA is gradually reduced and phased out if your modified AGI is between $95,000 and $110,000 (between $190,000 and $220,000 if filing MFJ).
The following requirements must be met in creating a Coverdell ESA:
• The trustee or custodian must be a bank in the U.S. approved by the IRS.
• The custodian can only accept a contribution if: (a) it is in cash, (b) is made before the beneficiary reaches age 18, or for a special needs beneficiary over 18, and (c) is made by the due date of the contributor's tax return, excluding extensions.
• Money in the account cannot be invested in life insurance contracts.
• Money in the account cannot be combined with other property, except in a common trust fund or common investment fund.
• If there is a balance in the Coverdell ESA when the beneficiary reaches age 30, it must generally be distributed within 30 days. The portion representing earnings on the account will be taxable, and also subject to the additional 10% tax. The beneficiary may avoid these taxes by rolling over the full balance to another Coverdell ESA for another family member.
• The custodian can only accept a contribution if: (a) it is in cash, (b) is made before the beneficiary reaches age 18, or for a special needs beneficiary over 18, and (c) is made by the due date of the contributor's tax return, excluding extensions.
• Money in the account cannot be invested in life insurance contracts.
• Money in the account cannot be combined with other property, except in a common trust fund or common investment fund.
• If there is a balance in the Coverdell ESA when the beneficiary reaches age 30, it must generally be distributed within 30 days. The portion representing earnings on the account will be taxable, and also subject to the additional 10% tax. The beneficiary may avoid these taxes by rolling over the full balance to another Coverdell ESA for another family member.
The balance in a Coverdell ESA account must be withdrawn within 30 days after the earliest of the following events: (a) the date the beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary, or (b) the beneficiary's death.
Qualified Tuition Program (529 Plan)
A qualified tuition program, also known as a 529 plan or program, is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as "qualified tuition plans," are sponsored by states, state agencies, or educational institutions, and are authorized by Section 529 of the Internal Revenue Code. A 529 plan is a program set up to allow you to prepay, or contribute to an account established for paying a student's qualified education expenses at an eligible educational institution.
The following rules apply to 529 plans:
• The designated beneficiary: This is generally the student (or future student) for whom the qualified tuition program is intended to provide benefits. You can change the designated beneficiary after participation in the program begins.
• Contributions: Your contributions to a qualified tuition program on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary. There are no income restrictions on the individual contributors.
• Distributions: The part of the distribution representing the amounts paid or contributed to a qualified tuition program are not included in taxable income; they are a return of the investment in the plan. The designated beneficiary does not have to include in taxable income any earnings distributed from a qualified tuition program if the total distribution is less than or equal to the qualified education expenses.
• Qualified educational expenses: These expenses are the tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student.
• Coordination with American opportunity and lifetime learning credit: An American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a qualified tuition program, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces qualified education expenses by the tax-free assistance, he/she must further reduce them by the expenses taken into account in determining the credit.
• Coordination with Coverdell ESA distributions: If a designated beneficiary receives distributions from both a qualified tuition program and a Coverdell ESA in the same year, and the total of these distributions is more than the beneficiary's adjusted higher education expenses, the expenses must be allocated between the distributions. For purposes of this allocation, you must disregard any qualified elementary and secondary education expenses.
• Coordination with tuition and fees deduction: A tuition and fees deduction can be claimed in the same year you take a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after you reduce qualified education expenses by tax-free education assistance, you must further reduce them by the expenses taken into account in determining the deduction.
• Additional tax on taxable distributions: Generally, if you receive a taxable distribution, you must pay a 10% additional tax on the amount that you have to include in income.
Education Savings Bond Program
You may exclude from taxable income all or part of the interest received on the redemption of qualified U.S. Savings Bond (Series EE bonds issued after 1989) if the proceeds are used for higher educational expenses during the same year. The expenses must be for tuition and fees only, and can be for you, your spouse, or your dependents.
If the higher educational expenses are more than or equal to the proceeds (interest and principal) from the bonds, you exclude all the interest.
If the educational expenses are less than the proceeds, only part of the interest can be excluded from income. To figure the excludable amount, apply the following formula: Excludable interest = interest x (educational expenses divided by bond proceeds).
To be eligible to exclude interest, your modified adjusted gross income must be less than $86,100 ($136,650 if filing MFJ or Q/W).
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