Last week's column addressed deductions for education expenses. This week we are looking at tax credits for education. What is the difference? A tax deduction lowers your income. If you can deduct $100 from your income and your tax rate is 25%, you save $25 in taxes.
On the other hand, if you qualify for a tax credit of $100; the $100 reduces the tax bill (not the income) and directly gives you a $100 tax savings. Given this choice, the credit is obviously more valuable to the taxpayer than the deduction.
There are two tax credits for higher education: The American Opportunity Credit and the Lifetime Learning Credit. The American Opportunity Credit (formerly the HOPE Credit) provides a refundable tax credit of up to $2,500 for undergraduate education. It is scheduled to expire at the end of 2012. The Lifetime Learning Credit provides a tax credit of 20% of tuition spent up to $2,000 for any level of college education. Here are the contrasting particulars for each credit.
American Opportunity Credit (AOC)
- The credit covers four years of undergraduate college study only.
- The student must be at least a half time student.
- The credit covers tuition plus books, lab fees, software, etc.
- Credit is 100% of first $2,000, plus 25% of the next $2,000, for a maximum of $2,500 per year for the four years of college.
- Credit is 40% refundable. Refundable means if no tax is owed, you can still get a refund check for the part of this credit not used to reduce your tax bill.
- Phase out of the credit begins at $80,000 Adjusted Gross Income (AGI) and ends at $90,000 for single filers. The range is $160,000 to $180,000 for joint filers.
Lifetime Learning Credit (LLC)
- The credit covers any post-secondary education even trade school.
- There is no course minimum; even one course will qualify the taxpayer for this credit.
- Credit is based on money spent on tuition and registration fees only, not books or equipment.
- Credit is 20% of all tuition paid up to a maximum credit of $2,000.
- Credit is 0% refundable.
- Phase out of the credit begins at $50,000 AGI and ends at $60,000 for single filers. The range is $100,000 to $120,000 for joint filers.
Common Provisions
For both programs, tuition means tuition paid. It is exclusive of any scholarships used and any refunds or reimbursements by employers. Money borrowed and paid as tuition does count as tuition. Money given to the student to pay tuition or directly to the school does not reduce tuition paid.
Notice that the phase-out ranges are for single filers and joint filers. These credits are not available to those filing as married filing separately.
To claim either credit, use form 8863.
Comparison to deductions
Be sure to compare these credits with tuition fees and deductions. While a credit is generally better than a deduction, the filer might get a better deal (or the only deal) with a deduction. The deduction (maximum of $4,000) begins to phase out at $65,000 AGI and ends the phase out at $80,000 for single filers and has a range of $135,000 to $160,000 for joint filers.
Summary
The AOC is generally the best option, but it is the most restrictive in terms of student course load, type of institution and the number of years (4) it can be used. The LLC is generally second best, but it is open to more diverse student loads and institutions but has a lower phase out range. The deduction would be the last choice.
Suppose junior is finishing his degree work in his fifth year and mom and dad have an AGI of $130,000. The fifth year rules out the AOC, and their AGI rules out the LLC. If $4,000 is spent and the deduction (and only the deduction) is available, that's still $1,000 off of the tax bill at the 25% bracket.
Suppose Dad takes accounting courses for a better job and spends $4,000 at the local community college. The AOC is out because he's not a full time student and it's not part of a four year program. The LLC qualifies him for 20% of $4,000 for an $800 credit. However, applying the same $4,000 to the allowable above the line deduction would yield a $1,000 lower tax bill in the 25% bracket. The deduction is better in this case.
