By Michelle Botwinick, C.P.A.
You may be able to turn part of the higher education expenses you pay for yourself, your spouse, or your dependents into tax savings. You can do this by claiming the American Opportunity tax credit and/or the Lifetime Learning credit for tuition and related expenses.
The maximum American Opportunity tax credit a taxpayer may claim is $2,500 per student for the first four years of undergraduate education at an eligible educational institution. That’s 100-percent of the first $2,000 of higher-education tuition and related expenses plus 25-percent of the next $2,000 of those expenses. The maximum Lifetime Learning credit that may be claimed is $2,000 per year per taxpayer, for any post-high school education (including graduate-level courses and courses to acquire or improve job skills) at an eligible educational institution.
Generally, eligible educational institutions are accredited schools offering credit toward a bachelor’s or associate’s degree or other recognized post-high school credential, and certain vocational schools.
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 who has never been convicted of a federal or state felony drug offense. The Lifetime Learning credit isn’t subject to the eligible student/felony drug offense restrictions, and may be available for a student taking only one course.
The Lifetime Learning credit is nonrefundable—i.e., it can reduce regular income taxes to zero but cannot result in the receipt of a refund. The credit may be claimed against the alternative minimum tax (AMT). The American Opportunity tax credit, on the other hand, is 40-percent refundable. This means that you can get a refund if the amount of the credit is greater than your tax liability. For example, someone who has at least $4,000 in qualified expenses and who would thus qualify for the maximum credit of $2,500, but who has no tax liability to offset that credit against, would qualify for a $1,000 (40-percent of $2,500) refund from the government. In addition, the American Opportunity tax credit may be claimed against a taxpayer’s AMT.
The American Opportunity/Lifetime Learning credits are based on the payment of “qualified tuition and related expenses.” These are the expenses for tuition and academic fees that are required for enrollment or attendance at an eligible educational institution. Qualified tuition and related expenses do not include student activity fees, athletic fees, insurance, room and board, transportation costs and other personal living expenses. They also don’t include courses involving sports, games, or hobbies, unless they are part of the student’s degree program. Books are qualified expenses under the American Opportunity tax credit, but not the Lifetime Learning credit.
The amount of qualified tuition and related expenses taken into account in computing the American Opportunity/Lifetime Learning 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.
Both 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 singles with income between $80,000 and $90,000. The Lifetime Learning credit is phased out for couples with income between $104,000 and $124,000 for 2012, or singles with income between $52,000 and $62,000. (The phase-out range for the Lifetime Learning credit is adjusted annually for inflation.)
Neither credit is available for taxpayers who are married filing separately.
In addition, neither credit is allowed to an individual who is claimed as a dependent on another’s return. In this situation, the credits are allowed instead to the taxpayer claiming that individual as a dependent, and the credits are based on the total qualified tuition and related expenses paid both by the taxpayer and the student. But if no one claims the student as a dependent on a tax return for the year, the credits are allowed to the student on his or her own return, based on the expenses paid by the student. In either case, the student’s credit takes into account the expenses that a third party (e.g., the student’s grandparent) pays to the eligible educational institution directly.