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Take Advantage of Two Education Tax Credits

Updated for Tax Year 2017


OVERVIEW

The American Opportunity credit and the more familiar Lifetime Learning credit can make higher education costs more affordable.


The American Opportunity credit covers up to $2,500 of undergraduate costs

In 2009, Congress replaced the well-known Hope Scholarship credit with the more generous American Opportunity credit.

The American Opportunity credit equals 100% of the first $2,000 of a student’s qualified education expenses plus 25% of the next $2,000. The maximum annual credit is $2,500.

Who can claim the credit?

You can claim the American Opportunity credit for qualified education expenses you pay for a dependent child as well as for expenses you pay for yourself or your spouse. If you have several students in your family, you can claim multiple credits based on the expenses of each student. For example, if you have three kids in college, you can claim up to $7,500 ($2,500 x 3) in American Opportunity credits.

The credit is not allowed for a student who has completed the first four years of post-secondary education as of the beginning of the year. So, if your child completed less than four years of college as of January 1, 2017, you can claim the credit on your 2017 return.

Note: You can only claim the credit for a year during which the student carries at least a half-time course load for a minimum of one semester beginning in that year. Additionally, the student must be enrolled in a program that leads to an associates or bachelors degree or some other recognized credential.

Which expenses are covered?

Expenses covered by the credit include tuition and mandatory enrollment fees and the cost of books and course materials. Room and board do not count as qualified expenses nor do optional fees to cover things like student health insurance, athletics and other activities.

To qualify, students must attend an eligible institution. Almost all accredited public, nonprofit and for-profit postsecondary schools (including many trade schools) fit this description. To make sure a school is eligible, go to fafsa.gov and verify that it has a Federal School Code.

Income phase-out rule

The American Opportunity credit is phased out if your modified adjusted gross income (MAGI) exceeds certain levels. (MAGI is adjusted gross income plus certain tax-free income from sources outside the United States.)

  • For 2017, the MAGI phase-out range for unmarried individuals is $80,000 to $90,000.
  • The MAGI phase-out range for married couples filing jointly is $160,000 to $180,000.
  • Regardless of your income, you are not eligible if you use married filing separate status.

Credit is partially refundable

Your American Opportunity credit is 40% refundable. That means a portion of the credit will be refunded to you even if you don’t owe any federal income tax.

Here’s how it works. Say your American Opportunity credit is $2,500. The refundable portion is $1,000 ($2,500 x 40%). That amount is treated as a payment on your tax return (as if you had the $1,000 withheld from your wages).

The remaining $1,500 ($2,500 x 60%) is a nonrefundable credit that provides a benefit to you only if you owe federal income taxes. If you don’t owe any federal income tax because of deductions and other credits, the entire $1,000 refundable credit counts as a tax overpayment and is refunded to you.

For example, if you owe $1,900 in taxes, the nonrefundable $1,500 portion of the credit is used first to reduce your tax bill to $400. Then the first $400 of the refundable credit is used to lower your tax bill to zero. Finally, the last $600 of the refundable credit is paid to you as a tax refund.

If your federal income tax bill is $4,500, the $1,500 nonrefundable portion of the credit reduces your tax bill to $3,000. Then the $1,000 refundable credit further reduces your tax bill to $2,000.

The Lifetime Learning credit covers up to $2,000 of undergraduate and graduate school costs

The rules for the Lifetime Learning credit are unchanged from prior years. As before, the credit is 20% of up to $10,000 of qualified education expenses. So the maximum credit for 2017 is $2,000 before any phase-outs.

Eligibility rules and qualified expenses

The Lifetime Learning credit can help cover undergraduate costs for a student who is not eligible for the American Opportunity credit because he or she is carrying a limited course load or already has four years of college credit. Additionally, the Lifetime Learning credit can also help cover the cost of graduate school and of courses taken to maintain or improve job skills.

You can claim the Lifetime Learning credit for qualified education expenses you pay for a dependent child as well as for yourself or your spouse. However, the maximum amount of covered expenses is $10,000 no matter how many students you have. This translates into a $2,000 maximum credit ($10,000 X 20%).

Qualified expenses include tuition and mandatory enrollment fees at an eligible institution. Books and course materials can also count, but only if you are required to purchase them directly from the school. Other expenses, such as optional fees and room and board, do not qualify.

Warning: You can’t claim both the American Opportunity credit and the Lifetime Learning credit for the same student for the same year. However, you can potentially claim the American Opportunity credit for one or more students and the Lifetime credit for up to $10,000 of qualified expenses for other students in your family.

Income phase-out rule

Like the American Opportunity credit, the Lifetime Learning credit is phased out if your modified adjusted gross income (MAGI) exceeds certain (much lower) levels.

  • For 2017, the MAGI phase-out range for unmarried individuals is $56,000 to $66,000.
  • The MAGI phase-out range for married couples filing jointly is $112,000 to $132,000.
  • Regardless of your income, you are not eligible if you use married filing separate status.

Claiming the credits

The rules for these credits can be tricky—especially when it comes to handling the refundable portion of the American Opportunity credit. TurboTax will show you which education credits will get you the best tax advantage, do all the calculations and complete all the forms for you. Just answer some simple questions and let TurboTax take care of the rest.

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Looking for more information?

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.


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