For tax years, 2010, 2011, and 2012, the American Opportunity Tax Credit (AOTC) provides a maximum credit amount of $2,500 per year for all four years of college.
Enacted by the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act), and extended by the Tax Relief, Unemployment Insurance Re-authorization, and Job Creation Act of 2010, the AOTC credit temporarily replaces and enhances the HOPE credit, which applied only to the first two years of college, and applies it to all four years of post-secondary education. The new credit can reach as high as 100 percent of up to $2,000 qualified higher education expenses plus 25 percent of the next $2,000 of eligible expenses. The credit begins to "phase out" for married couples filing jointly with adjusted gross income (AGI) between $160,000 and $180,000. The credit begins to a phase out for single individuals with AGI between $80,000 and $90,000. Forty percent of the credit is refundable for those lower-income taxpayers with a tax liability smaller than the credit amount and to qualify the tuition must be paid on behalf of the taxpayer, spouse or dependent (Code Sec. 25A (f)(1)(A)). A taxpayer who is attending a vocational school may also be eligible (Code Sec. 25A(f)(2); Reg. §1.25A-2(b)).
Qualified expenses must be for tuition and related expenditures; however, it does not include expenses for room and board (Reg. §1.25A-2(d)(3)). Expenses incurred for classes on sports or hobbies are not contemplated qualified expenditures. Many nonacademic fees are also not considered for purposes of the credit. Room and board costs, moreover, are not in the definition of qualified tuition and related expenses.
Lifetime Learning credit Code Sec. 25A. Before the 2009 Recovery Act enhanced the HOPE credit (and renamed it the AOTC), the discrepancies between the HOPE credit and the Lifetime Learning credit were more prominent. The HOPE credit is available for the first two years of post-secondary education (Code Sec. 25A(b)(2)(C)). The Lifetime Learning credit is available for post-secondary education, including technical or remedial training as long the train is to improve the job skill it can be claimed for an unlimited number of tax years (and not just for the first two years of college as was the HOPE credit before the 2009 Recovery Act). The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. The Lifetime Learning credit is a subject to phase out rules. The credit begins to phase out for married couples filing jointly with more than $80,000 in AGI in 2012 (Code Sec. 25A(d)) and it is adjusted for inflation (Code Sec. 25A(h)(2)). The credit begins to a phase out for single individuals with more than $40,000 in AGI in 2012.
Qualified expenses for the Lifetime Learning credit are similar to the enhanced HOPE credit as defined in Code Sec. 25A(f) (Code Sec. 222(d)). The expenses must be enrolled during the tax year (Code Sec. 222(d)(3)(B)). However, taxpayer cannot deduct or claim a double tax benefit. For example, if an expense is deductible under any other provision, it cannot be deductible under Code Sec. 222. The deduction allowed depends on the individual’s adjusted gross income (AGI) (Code Sec. 222(b)(2)(B)(i). No deduction is allowed to any taxpayer for whom an exemption is claimed by another taxpayer for the tax year (Code Sec. 222(c)(3)).
The Lifetime Learning credit may be applied to a non-degree program. For example, a person who is enrolled in a non-degree program to improve job skills may be eligible for the credit. Moreover, the Lifetime Learning credit may be claimed if the student is not enrolled at least half-time. A person who is taking just one class at a community college; for example, he may be eligible for the credit.
Qualified tuition and related expenses are the same for the Lifetime Learning credit. Most nonacademic fees, such as sports and student activity fees are excluded. The maximum deductible amount is $4,000 for individuals with adjusted gross income not exceeding $65,000 ($130,000 for married couples filing jointly). Individuals with adjusted gross incomes between $65,000 and $80,000 (married couples filing jointly with adjusted gross incomes between $130,000 and $160,000) may deduct up to $2,000.
Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for the beneficiary's enrollment at an eligible educational institution, which includes most institutions that participate in federal student aid programs. If the student is attending an institution at least half-time, room and board are also treated as a qualified expense. (§481 of the Higher Education Act of 1965 (20 U.S.C. 1088)).
Employer-provided educational assistance exclusion (Code Sec. 127). When an employer pays an employee's education expenses, the tax consequences depend on the reason for the education. A person’s employer may have a plan under which it pays for qualified education expenses for college or graduate studies. If it has such a plan, up to $5,250 of education benefits can be excluded from the recipient's gross income each year, through 2012.Employer provides educational assistance can include tuition, fees, books, supplies and equipment.
Job-related educational expenses. If a person is taking a course because it is directly related to improve his job performance and his employer does not cover it. He may be able to deduct it as a miscellaneously itemized deduction if he itemized deductions. Under this deduction; tuition, course materials, and even the cost of transportation to and from class may be deductible. There are some restrictions; however: miscellaneous deductions are deductible only above two percent of his adjusted gross income and any degree program that qualify an individual for a "new trade or business" cannot be deducted under this provision no matter how useful it also may be to his current job.
Deduction for interest on education loans. A student can deduct loan interest on qualified education loans, which is above-the-line deduction (Code Sec. 221; Reg. §1.6050S-3). The maximum student loan interest that can be deducted is $2,500 per year; however, the deduction is phased out for taxpayers with Adjusted Gross Income above a certain amount indexed for inflation. Code Sec. 221(b)(2). Student loan interest of up to $2,500 a year is deductible whether he itemizes his deductions. An enhanced interest deduction is available for tax years 2010 through 2012. The deduction is fully phased when a taxpayer’s modified AGI exceeds certain thresholds. The deduction is phased-out for single individuals with modified AGI above $75,000 in 2012. The deduction is totally phased out for married couples filing jointly with modified AGI above $150,000 in 2012. However, the rules can be tricky. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person's return cannot take this deduction. Qualified educational institutions for the student loan interest deduction are ones that participate in federal student aid programs.
Coordination. There are several federal education tax incentives. All of the incentives must be coordinated. A person cannot use education expenses to claim a double benefit. Many taxpayers make genuine and honest mistakes when trying to coordinate the education incentives without help from a tax professional.