Education Tax Credits: Softening the Sting of Tuition & Related Expenses for Qualifying Taxpayers

By Baker Newman Noyes December 7, 2013

With tuition payments for the upcoming spring semester looming, we thought it helpful to provide an overview of the education credits currently available. This article provides an overview of the American Opportunity Credit and Lifetime Learning Credit, explains who is eligible for the credits, and discusses the related timing rules.

American Opportunity Credit

The American Opportunity credit, available from 2013 through 2017, is for the first $2,000 spent on qualified tuition and related expenses (explained below), plus 25% of the next $2,000 spent on education expenses up to a maximum credit of $2,500 per eligible student per year. The student must be enrolled at least half-time in the first four years of undergraduate education and must either be a dependent of the taxpayer claiming the credit or claiming her own personal exemption. Payments made directly to a qualified educational institution by a third party – such as a grandparent – may be taken into account in calculating the allowable credit.

The American Opportunity Credit can only be taken in full by taxpayers with modified adjusted gross income (MAGI) of less than $80,000 (single filers) and $160,000 (joint filers). It begins to phase out after these limits and is completely unavailable for taxpayers with MAGI over $90,000 (single filers) and $180,000 (joint filers). In general, MAGI is income less certain adjustments and includes, among other things, any foreign source income that might otherwise be excluded, tax-exempt interest, and passive losses.

The best feature of the American Opportunity Credit is that it is partly refundable. If your tax liability is not high enough to take advantage of the full $2,500 credit, you may still receive up to a $1,000 refund from the credit.

Lifetime Learning Credit

The Lifetime Learning Credit amount is 20% of qualified tuition expenses paid on the first $10,000 of tuition (not adjusted for inflation), for a maximum credit of $2,000. It is calculated per taxpayer rather than per student. A student is eligible if enrolled in at least one post-secondary education class at a qualified education institution. Similar to the American Opportunity Credit, the student must either be a dependent of the taxpayer claiming the credit or claiming his own personal exemption.

For 2013, this credit begins to phase out when MAGI is $53,000 (single filers) and $107,000 (joint filers) and is completely phased-out for taxpayers with MAGI over $63,000 (single filers) and $127,000 (joint filers).

Note that the taxpayer cannot claim both of the above credits for the same student in the same year or claim the credit for the same expenses paid.

Qualified Expenses

Qualified tuition and related expenses must be incurred by the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent who is an eligible student at a “qualified educational institution,” which is essentially any college eligible to participate in a student aid program administered by the Department of Education. Qualified expenses include only tuition and related fees. They do NOT include room, board, books (although course materials qualify for the American Opportunity Credit), student health fees, or transportation. Expenses paid with any tax-free scholarship proceeds reduce the amount of credit available.

Further limitations apply.  Qualified expenses must be reduced by any refund of such expenses received from an educational institution during the same taxable year. If in one year the taxpayer receives a refund of expenses paid for which the taxpayer claimed an education credit in a previous year, the taxpayer must increase his or her current year tax by the amount of the tax benefit received in the prior year.

Timing the Payments

In general, taxpayers can only take an education credit for an academic period beginning in the same taxable year as the year in which the payment is made. This means that if the fall semester’s tuition is paid in August of 2013, the credit can only be taken on the taxpayer’s 2013 tax return, assuming all of the other eligibility requirements are met. However, there is an exception for prepaying the tuition. If tuition is paid in one taxable year for a semester that begins in the first three months of the next taxable year (January, February, or March), then the credit can be taken in the year in which the payment was made. For example, if, in December of 2013, the taxpayer writes a check for the spring semester’s tuition that begins in January of 2014, he or she can take the credit on his or her 2013 tax return, even though the academic period did not begin in 2013.

This article is intended to be simply a summary of the education credits currently available. If you think you might qualify for a credit or have any questions, please contact Natalie Solotoff or your regular BNN advisor at 1.800.244.7444.