Education Tax Benefits
The Federal Relief Act of 1997 provides opportunities for tax savings through the Hope Scholarship Credit or the Lifetime Learning Credit and provides for a deduction for student loan interest paid. The Economic Growth and Tax Relief Reconciliation Act of 2001 made some modifications to Education IRAs (now known as Coverdell Education Saving Accounts) as well as to the limits on the student loan deduction. The following is a brief description of the credits, the deduction, and other education incentives available for the 2006 tax year. Income limitations and tuition expenses will be adjusted for inflation. This does not constitute legal or tax advice. Please consult with a tax professional to discuss your personal situation and any changes or revisions to the tax law. You can also find out more details in IRS Publication 970.
The Hope Scholarship Credit and The Lifetime Learning Credit
There are two education-related credits: the Hope Scholarship Credit and the Lifetime Learning Credit. These credits may be claimed by individuals for qualified tuition and related expenses incurred by students pursuing college or graduate degrees or vocational training (Code Sec. 25A). These credits are reported on IRS Form 8863. The Hope Scholarship Credit provides a maximum allowable credit of $1,650 per student for each of the first two years of post-secondary education. The Lifetime Learning Credit allows a credit of 20 percent of qualified tuition and related expenses paid by the taxpayer for any year the Hope credit is not claimed, with the maximum allowable credit of $2,000.
Specifically, the Hope Scholarship Credit initially allows taxpayers a 100-percent credit per eligible student for the first $1,100 of qualified tuition and related expenses (but not room, board or books) and a 50-percent credit for the second $1,100 of qualified expenses paid. The Lifetime Learning Credit is equal to 20 percent of the amount of qualified tuition and related expenses paid by the taxpayer and is available for the first $10,000 of qualifying expenses paid.
Eligibility
Both credits are available for qualified tuition and related expenses incurred for the taxpayer, the taxpayer's spouse, or the taxpayer's dependent at an eligible educational institution (Code Sec. 25A(b)(3) and (f)). The $1,650 maximum Hope credit is allowed per student. In contrast, the Lifetime Learning Credit maximum is calculated per taxpayer and does not vary based on the number of students in the taxpayer's family. The credits are elective and nonrefundable (Code Sec. 25A(e)(1)). No double benefit is permitted; the credits are not permitted to more than one taxpayer in the same year (i.e., either parent or dependent child may take credit), and cannot be claimed for the same expenses for which another tax benefit is also received.
The $1,100 amount of qualified tuition expenses eligible for the Hope scholarship credit and the amount used to compute the credit under the formula in Code Sec. 25A(b)(1) are adjusted for inflation (as are the income limitations below). No inflation adjustment is provided for the $10,000 qualified expense amount used to determine the amount of the Lifetime Learning Credit.
Income Limitations
The allowable amount of the credits is reduced for taxpayers who have Modified Adjusted Gross Income (MAGI) above certain amounts. The phase-out of the credits begins for most taxpayers when MAGI reaches $47,000; the credits are completely phased out when MAGI reaches $57,000. For joint filers, the phase-out range is $94,000 to $114,000 (Code Sec. 25A(d)). The Hope credit and the Lifetime Learning Credit are not available to married taxpayers who file separate returns (Code Sec. 25A(g)).
Coordination with Other Provisions
For tax years beginning after December 31, 2001, the Tax Relief Act allows a taxpayer to claim a Hope credit or Lifetime Learning Credit for a taxable year and to exclude from gross income amounts distributed from a Coverdell Education Savings Account on behalf of the same student as long as the distribution is not used for the same educational expenses for which a credit was claimed.
Student Loan Interest Deduction
Taxpayers who have taken loans to finance an education at an eligible institution (a university, college, vocational school, or other post-secondary school that is qualified to participate in federal student aid programs) may be qualified to deduct interest they pay on loans for themselves, their spouse or dependent. The maximum deductible amount of interest is $2,500.
The student must be enrolled at least halftime in an eligible institution. Expenses that are eligible for the deduction include tuition, fees, books, room and board, supplies, and other related educational expenses. The amount of the deduction is gradually reduced for taxpayers with a modified adjusted gross income between $55,000 and $70,000 (between $110,000 and $140,000 for married taxpayers filing jointly). Taxpayers who have a modified adjusted gross income above $65,000 ($135,000 for married taxpayers filing jointly) cannot claim the student loan interest deduction. If a student is claimed as a dependent on another taxpayer's return or if his/her filing status is married filing separately, then he/she cannot claim the deduction during that tax year. The income limitations will be adjusted for inflation.
Other Education Incentives
Taxpayers are permitted to deduct qualified higher education expenses paid by the taxpayer during the year. Taxpayers with modified adjusted gross income that does not exceed $65,000 ($130,000 in the case of married couples filing joint returns) are entitled to a maximum deduction of $4,000 per year. The amount of the deduction is reduced to $2,000 for taxpayers with a modified adjusted gross income between $65,000 and $80,000 (between $130,000 and $160,000 for married taxpayers filing jointly). Taxpayers with modified adjusted gross income above these thresholds are not entitled to a deduction.
Taxpayers whose modified adjusted gross income is less than $110,000 (single filers) or $220,000 (if filing a joint return) may be able to take advantage of a Coverdell Education Savings Account (ESA). The annual limit on Coverdell ESA is $2,000 per child.
Please see IRS Publication 970 for more details about these credits and deductions.