Bigger, Better College Tax Credit

The law renames the Hope College credit for 2009 and 2010—it’s now known as the American Opportunity tax credit—and hikes its value from $1,800 to $2,500 for 2009 and 2010.

Because a tax credit reduces your tax bill dollar for dollar, this basically means Uncle Sam will give you up to $2,500 per year for each qualifying college student in your family.

And, unlike the old Hope credit, which was available only for a student’s first two years of college, the new American Opportunity credit can be claimed for four years of post-high-school education. You get the maximum credit if you spend at least $4,000 in qualifying expenses, which now include the cost of books as well as tuition and fees.

If you're a lower-income taxpayer and the credit is worth more than your tax bill for the year, up to 40 percent of the credit (as much as $1,000) will be paid to you as a tax refund. The old Hope credit could wipe out your tax bill but never give you cash back.

There’s also good news for some higher-income taxpayers: The new rules greatly expand the number of families who will qualify for the credit. The old Hope credit was phased out for single taxpayers with Adjusted Gross Income (AGI) greater than $50,000 and it disappeared altogether at $60,000. For couples filing jointly, the credit phased out between $100,000 and $120,000 of AGI. (AGI is basically taxable income before subtracting personal and dependent exemptions and standard or itemized deductions.)

Now the credit starts to decrease at $80,000 for single taxpayers and disappears at $90,000. For married taxpayers filing jointly, those thresholds are now $160,000 and $180,000.

Note: None of these changes affect the 2008 tax return you’re working on now. They apply first in 2009, so you’ll see the benefit when you file your 2009 return in 2010.

What if you already used the Hope credit for the first two years of a child’s college bills? If your child is a junior in 2009, you can use the American Opportunity credit for the child’s junior and senior years.

The other rules for qualifying for the American Opportunity credit are the same as for the Hope credit.

The student must be enrolled at least half-time in a program pursuing an undergraduate degree or other recognized educational credential. You can claim the credit for expenses paid for yourself, your spouse, or a child who is claimed as a dependent on your tax return. If the student is claimed as a dependent on a parent’s tax return, the parent gets the credit, regardless of who actually pays the qualifying expenses.

The changes in the Hope credit do not affect the Lifetime Learning credit (which applies to higher education not covered by the Hope or American Opportunity credit) for education after the first two or four years, or for classes taken (1) less than half-time or (2 ) not in pursuit of a degree.

The Lifetime Learning credit, which can be claimed for graduate school, for example, or a single post-high-school class, is worth up to $2,000. (The credit is actually 20 percent of the first $10,000 of qualifying costs.) The income phase-out zone is lower than for the new American Opportunity credit. For 2008 and 2009 returns, the Lifetime Learning credit gradually disappears as AGI rises from $50,000 to $60,000 on single returns and from $100,000 to $120,000 on joint returns.

Despite all the improvements, some parents should skip the American Opportunity credit and instead stick with the Hope credit when they file their 2009 returns in 2010. This applies to families with students who are freshmen or sophomores in colleges and universities in parts of the Midwest.

As part of legislation designed to aid victims of the 2008 floods and other weather-related disasters, Congress doubled the Hope credit for students attending school in parts of seven states: Arkansas, Illinois, Indiana, Iowa, Missouri, Nebraska and Wisconsin. That means qualifying students can receive a Hope credit worth $3,600 in 2009—$1,100 more than the new, improved American Opportunity credit. IRS publication 970 has a list of the counties in each state in which qualifying schools are located.