How do Education Tax Credits Work?
There are two federal education tax credits that can cut your tax bill by thousands of dollars. You’ll save more with the American Opportunity Credit – up to $2,500 per student – but it’s typically only available for the first four years of college or trade school. The Lifetime Learning Credit maxes out at $2,000 per year, but there’s no limit on the number of years you can claim it and the eligibility requirements are less stringent.
Key Takeaways
- The American Opportunity Tax Credit is worth up to $2,500 per student and is generally only available for undergraduate students attending school on at least a half-time basis who haven't completed the first four years of post-secondary education.
- The Lifetime Learning Tax Credit offers up to $2,000 in tax savings. It’s generally more accessible than the American Opportunity Credit, since it doesn't have a limit on the number of years it can be claimed. It’s also available for courses taken to acquire or improve job skills without pursuing a degree.
- Both education credits are phased out if your modified adjusted gross income is between $80,000 and $90,000 ($160,000 and $180,000 for married couples filing a joint tax return).
- The American Opportunity Credit is partially refundable (up to $1,000), while the Lifetime Learning Credit is non-refundable, meaning it can reduce the tax you owe to $0 but won't result in a refund.
What are education tax credits?
The price of an education after high school is eye-popping. On average, it now costs well over $30,000 for a year of tuition, fees, books, supplies, and living expenses at a four-year college. Trade school is also expensive – averaging around $15,000 per year. Either way, covering higher education costs is a challenge for many people.
On the other hand, your earning potential can increase significantly as your level of education increases. So, higher education is generally a good overall investment. But paying for it can still be difficult, so any type and amount of financial assistance is helpful.
That’s where the two federal education tax credits come into play. While the American Opportunity Tax Credit and Lifetime Learning Tax Credit won’t cover the bulk of your education expenses, they can provide some relief from the costs of obtaining a degree or of classes taken to improve your job skills.
So that you don’t miss out on these valuable tax breaks, check out the information below on the American Opportunity Credit and Lifetime Learning Credit. If you’re taking college or trade school classes, or thinking of enrolling in the future, you’ll want to look into these two education tax credits as you explore ways to pay for the high cost of higher education.
American Opportunity Tax Credit
Of the two education tax credits, the American Opportunity Credit is the more valuable credit (up to $2,500 per student), but it’s generally available to fewer people.
If you qualify for both credits for a single student, claim the American Opportunity Tax Credit instead of the Lifetime Learning Credit (you can’t claim them both for the same student in the same year). You’ll save more money, and you can still use the Lifetime Learning Credit down the road if you have additional education expenses.
Who can claim the American Opportunity Tax Credit?
The American Opportunity Tax Credit can cut your tax bill – and maybe trigger a tax refund – if you paid qualified higher education expenses for an eligible student. You can claim the credit for your own education expenses, or for those of your spouse or a dependent (such as your child).
However, in most cases, the credit is only available for undergraduate school. That’s because you can’t claim the credit if the student has completed the first four years of post-secondary education. Plus, you can only claim the credit for a maximum of four years per student.
The student must also be enrolled on at least a half-time basis in a program that leads to a degree, certificate, or other recognized education credential for at least one academic period that started (or was treated as started) during the tax year.
There are a number of other restrictions, too. For example, you can’t claim the American Opportunity Credit if any of the following are true:
- You’re claiming the Lifetime Learning Credit for the same student.
- The student has been convicted of a felony for possessing or distributing a controlled substance.
- Your filing status is Married Filing Separately.
- You’re claimed as a dependent on someone else’s tax return (such as on your parents’ return).
- You or your spouse were a nonresident alien for any part of the tax year and didn’t elect to be treated as a resident alien for tax purposes.
- You don’t have a Social Security number or Individual Taxpayer Identification Number (ITIN).
- The student (other than yourself) doesn’t have a Social Security number, ITIN, or Adoption Taxpayer Identification Number.
Also note that you might not be able to claim the American Opportunity Tax Credit in the future if you claim the credit when you're not eligible for it. You’ll be banned for two years if it’s determined that your ineligible claim was made with reckless or intentional disregard of the law. The ban will last for 10 years if your ineligible claim was due to fraud.
You also have to subtract any tax-free educational assistance (such as certain scholarships, grants, or employer-provided assistance) from your total qualified educational expenses.
TurboTax Tip:
If scholarship money or a fellowship grant is used for non-qualified expenses – such as room and board – the funds might not be tax-free. In that case, they don’t have to be subtracted from the qualified education expenses used to calculate the education tax credits. This could result in a larger education credit and an overall lower tax bill.
How much is the American Opportunity Tax Credit worth?
The American Opportunity Tax Credit is worth up to $2,500 per eligible student for each of the student’s first four years of college or trade school. This is calculated by adding the following two components:
- 100% of the first $2,000 of the student’s qualified education expenses for the year
- 25% of the next $2,000 of the student’s qualified education expenses for the year
However, the credit is phased-out if your income is above a certain amount. For married couples filing a joint return, the credit is gradually reduced if your modified adjusted gross income (MAGI) is $160,000 or more. It’s completely eliminated (reduced to $0) if your MAGI is $180,000 or more.
For all other people, the phase-out begins if your MAGI is more than $80,000. The credit is no longer available if your MAGI is $90,000 or more.
Is the American Opportunity Tax Credit refundable?
Up to 40% of the American Opportunity Tax Credit is refundable. So, if your credit amount is more than the tax you owe before the credit is applied, you can get a tax refund of up to $1,000 ($2,500 x .40 = $1,000).
There’s an exception to the refundability rules, though. The credit isn’t refundable if you’re under 24 years of age at the end of the tax year and all the following conditions apply:
- you were either:
- under age 18 at the end of the tax year
- age 18 at the end of the tax year and your earned income was less than 50% of your support
- age 19 to 23 at the end of the tax year, a full-time student, and your earned income was less than 50% of your support
- at least one of your parents was alive at the end of the tax year
- your filing status for the tax year isn’t married filing jointly
Lifetime Learning Tax Credit
Just because you earned an undergraduate degree doesn’t necessarily mean your college days are over. You can still go to grad school or take additional classes to get a better job. The Lifetime Learning Credit can help curb those costs, since it isn’t limited to your first four years of undergraduate study.
Even though the Lifetime Learning Credit is only worth up to $2,000 per year, there are also fewer restrictions when compared to the American Opportunity Tax Credit. As a result, it’s generally available to more people.
Who can claim the Lifetime Learning Tax Credit?
You can claim the Lifetime Learning Credit for qualified education expenses paid during the tax year for yourself, your spouse, or a dependent (such as your child). There are no limits on the number of years you can claim the credit, and you can claim the credit for just one or two classes (so there’s no half-time student requirement). The student doesn’t have to be enrolled in a degree program, either.
There are some familiar restrictions, though. For instance, the Lifetime Learning Credit isn’t available if any of the following are true:
- You’re claiming the American Opportunity Credit for the same student.
- Your filing status is married filing separately.
- You’re claimed as a dependent on someone else’s tax return (such as on your parents’ return).
- You or your spouse were a nonresident alien for any part of the tax year and didn’t elect to be treated as a resident alien for tax purposes.
What are qualified education expenses for the Lifetime Learning Tax Credit?
The Lifetime Learning Credit covers tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.
Student activity fees and course-related books, supplies, and equipment only count if they must be paid to the school for enrollment or attendance. Prepaid education expenses can also be used to calculate the credit if they’re paid for an academic period that begins in the first three months of the following year.
In addition, courses must be either part of a post-secondary degree program, or taken by the student to acquire or improve job skills.
The Lifetime Learning Credit can’t be claimed for:
- room and board
- classes involving sports, games, or hobbies that aren’t part of the student’s degree program
- medical expenses (including student health fees)
- insurance
- transportation
- personal, living, or family expenses
It’s also not allowed for education expenses used to calculate other tax deductions, credits, or exemptions (again, like a tax-free distribution from a 529 plan or a business expense deduction). Any tax-free educational assistance received by the student (such as certain scholarships, grants, or employer-provided assistance) also must be subtracted from your qualified educational expenses before calculating the Lifetime Learning Credit.
How much is the Lifetime Learning Tax Credit worth?
The maximum Lifetime Learning Credit is equal to 20% of the first $10,000 of qualified education expenses paid for all eligible students. That means the credit is capped at $2,000 per year.
As with the American Opportunity Credit, the Lifetime Learning Credit is gradually phased-out if your MAGI is more than $80,000 ($160,000 for married couples filing a joint return). The Lifetime Learning Credit is reduced all the way to $0 if your MAGI is $90,000 or more ($180,000 or more for joint filers).
Is the Lifetime Learning Tax Credit refundable?
No. The Lifetime Learning Credit is not refundable. As a result, the credit won’t trigger a tax refund if it’s greater than your pre-credit tax liability.
For example, if you owe $1,600 in tax before the credit is applied, and you qualify for a $2,000 Lifetime Learning Credit, your tax bill will drop to $0. However, you won’t get a tax refund for the remaining $400. In essence, you’ll lose $400 of the credit.
How to claim education tax credits
Use IRS Form 8863 to calculate both the American Opportunity Tax Credit and Lifetime Learning Tax Credit (including the refundable portion of the American Opportunity Credit). While you can’t claim both credits in the same year for the same student, you can claim both credits in the same year for different students. You can also claim both credits for more than one student.
The nonrefundable education credits from Form 8863 are then reported on Schedule 3 (Form 1040) with other nonrefundable credits. From there, the combined total of nonrefundable credits from Schedule 3 is reported on your Form 1040.
The refundable portion of the American Opportunity Tax Credit (if any) from Form 8863 is reported directly on your 1040 form.
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