The following two tax credits are available to persons who pay higher education costs.

• The Hope credit.
• The lifetime learning credit.

Rules That Apply to Both Credits

The amount of each credit is determined by the amount you pay for qualified tuition and related expenses for students and the amount of your modified adjusted gross income. These education credits are subtracted from your tax but they are nonrefundable. This means if the credits are more than your tax, the excess is not refunded to you.

If your filing status is Married filing separate return, you cannot claim the higher education credits.

What expenses qualify. The credits are based on qualified tuition and related expenses you pay for you, your spouse, or a dependent you claim on your tax return. In general, qualified tuition and related expenses are tuition and fees required for enrollment or attendance at an eligible educational institution. Fees for course-related books, supplies and equipment, and student activity fees are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. Qualified tuition and related expenses do not include the cost of insurance, medical expenses (including student health fees), room and board, transportation or similar personal, living or family expenses, even if the fee must be paid to the institution as a condition of enrollment or attendance.

Prepaid expenses. If you pay for qualified tuition and related expenses for an academic period that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit. For example, if you pay $2,000 in December 1998 for qualified tuition for the winter 1999 semester that begins in January 1999, you can use that $2,000 in figuring your 1998 credit.

You cannot use any amount you paid in 1997 in figuring higher education credits for your 1998 tax return.

Dependent. A dependent is a person for whom you claim a dependency exemption. This generally includes your unmarried child who is under age 19 or who is a full-time student under age 24 if you supply more than half the child's support for the year. (See chapter 3 for details on dependency exemptions.)

Eligible educational institution. An eligible educational institution is any accredited college, university, vocational school, or other accredited postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Academic period. An academic period includes a semester, trimester, quarter, or any other period designated by the educational institution as a period of instructional time. For purposes of the education credits, an academic period begins on the first day of classes and does not include periods of student orientation, counseling or vacation.

No double benefit allowed. If you claim a deduction for higher education expenses on your tax return, you cannot claim a credit for those same expenses.

Adjustments to qualified expenses. If you pay higher education expenses with certain tax-free funds, you cannot claim a credit for those amounts. Tax-free funds could include scholarships, Pell grants, employer-provided educational assistance, veterans' educational assistance, and any other nontaxable payments (other than gifts, bequests, or inheritances) received for educational expenses. You can, however, claim a credit for expenses paid with the student's earnings, loans, gifts, inheritances, and personal savings.

If a student receives a tax-free withdrawal from an education IRA in a particular tax year, none of that student's expenses can be used as the basis of a higher education credit for that tax year. However, the student can waive the tax-free treatment. See Education IRAs in chapter 18.

Recapture of credit. If, in a later tax year, you receive a refund of an expense you used to figure a higher education credit, you may have to repay all or part of the credit.

Hope Credit

For expenses paid after December 31, 1997, for academic periods beginning after that date, you may be able to claim a Hope credit of up to $1,500 for the qualified tuition and related expenses paid for each eligible student. This credit may be claimed for only two taxable years for each eligible student.

Eligible student for the Hope credit. You can claim a Hope credit only for an eligible student who meets all of the following requirements.

1. Has not completed the first two years of postsecondary education (generally, the freshman or sophomore years of college).
2. Is enrolled in a program that leads to a degree, certificate, or other recognized educational credential.
3. Is taking at least one-half of the normal full-time work load for his or her course of study for at least one academic period beginning during the calendar year.
4. Is free of any felony conviction for possessing or distributing a controlled substance.

Amount of credit. The amount of the Hope credit is 100% of the first $1,000 plus 50% of the next $1,000 you pay for each eligible student's qualified tuition and related expenses. The maximum amount of Hope credit you can claim in 1998 is $1,500 times the number of eligible students. This means that you can claim the full $1,500 for each eligible student for whom you pay at least $2,000 for qualified expenses. However, the credit may be reduced based on your modified adjusted gross income. See Income Phaseout, later.

Example. Jon and Karen are married and file a joint tax return. For 1998, they claim their daughter as a dependent on their tax return and their modified adjusted gross income is $70,000. Their daughter is in her sophomore (second) year of studies at the local university and Jon and Karen pay $4,300 in 1998 for her tuition costs.

Jon and Karen, their daughter, and the local university meet all of the requirements for the Hope credit. Jon and Karen can claim a $1,500 Hope credit in 1998. This is the maximum amount allowed for 1998.

How to figure the Hope credit. The Hope credit is figured in Parts I and III of Form 8863. An illustrated example using Form 8863 appears later.

Lifetime Learning Credit

For expenses paid after June 30, 1998, for academic periods beginning after that date, you may be able to claim a lifetime learning credit of up to $1,000 for the total qualified tuition and related expenses paid during the tax year for all students who are enrolled in eligible educational institutions. Unlike the Hope credit:

1. The lifetime learning credit is not based on the student's work load. It is allowed for one or more courses.
2. The lifetime learning credit is not limited to students in the first two years of postsecondary education.
3. Expenses for graduate-level degree work are eligible.
4. There is no limit on the number of years for which the lifetime learning credit can be claimed for each student.
5. The amount you can claim as a lifetime learning credit does not vary (increase) based on the number of students for whom you pay qualified expenses.

Amount of credit. The amount of the lifetime learning credit is 20% of the first $5,000 you pay for qualified tuition and related expenses for all students in the family. The maximum amount of lifetime learning credit you can claim for 1998 is $1,000 (20% times $5,000). However, that amount may be reduced based on your modified adjusted gross income. See Income Phaseout, later.

Example. Bruce and Toni are married and file a joint tax return. For 1998, their modified adjusted gross income is $50,000. Toni is attending the community college (an eligible educational institution) to earn credits towards an associate's degree in nursing; she already has a bachelor's degree in history and wants to become a nurse. In August 1998, Toni paid $2,000 for her fall 1998 semester. Bruce and Toni can claim a $400 (20% × $2,000) lifetime learning credit on their 1998 joint tax return.

How to figure the lifetime learning credit. The lifetime learning credit is figured in Parts II and III of Form 8863. An illustrated example using Form 8863 appears later.

Choosing Which Credit To Claim

For each student, you can elect for any tax year only one of the credits or a tax-free withdrawal from an education IRA. (See Education IRAs in chapter 18 for more information.) For example, if you elect to take the Hope credit for a child on your 1998 tax return, you cannot, for that same child, also claim the lifetime learning credit for 1998 or take a tax-free withdrawal from an education IRA for 1998.

Lifetime learning credit after Hope credit. You can claim the Hope credit for the first two years of a child's postsecondary education and claim the lifetime learning credit for that same child in later tax years.

More than one student. If you pay qualified expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. This means that, for example, you can claim the Hope credit for one child and the lifetime learning credit for another child in the same tax year.

Who can claim the credit. In any one tax year, only one person can claim a higher education credit for a student's expenses. If you are paying higher education costs for your dependent child, either you or your dependent child, but not both of you, can claim a credit for a particular year. If you claim an exemption for your child on your tax return, only you can claim a credit. If you do not claim an exemption for your child on your tax return, only your child can claim a credit.

If you claim an exemption for your child on your tax return, treat any expenses paid by your child as if you had paid them. Include these expenses when figuring the amount of your Hope or lifetime learning credit.

Income Phaseout

Your education credits are phased out (gradually reduced) if your modified adjusted gross income is between $40,000 and $50,000 ($80,000 and $100,000 in the case of a joint return).

You cannot claim any higher education credits if your modified adjusted gross income is over $50,000 ($100,000 in the case of a joint return).
 

Modified adjusted gross income. For most taxpayers, modified adjusted gross income will be their adjusted gross income (AGI) as figured on their federal income tax return. However, you must make adjustments to your AGI if you excluded income earned abroad or from certain U.S. territories or possessions or took a foreign housing deduction. If this applies to you, increase your AGI by the following amounts you excluded or deducted from your income.

1. Foreign earned income of U.S. citizens or residents living abroad.
2. Housing costs of U.S. citizens or residents living abroad.
3. Income from sources within Puerto Rico, Guam, American Samoa, or the Northern Mariana Islands.

How the phaseout works. The phaseout (reduction) works on a sliding scale. The higher your modified adjusted gross income, the more your credits are reduced. You figure the reduction, if any, in Part III of Form 8863, discussed next.

How To Claim the Credits

You figure the amount of your education credits by completing Form 8863. Use Part I for the Hope credit and Part II for the lifetime learning credit. In both parts, you enter the student's name and taxpayer identification number (usually a social security number) and the amount of qualified expenses paid in 1998. You then complete Part III to compute the amount to enter on line 44 of Form 1040 or line 29 of Form 1040A. Attach the completed Form 8863 to your return.

An eligible educational institution (such as your college or university) that receives payment of qualified tuition and related expenses should issue Form 1098-T, Tuition Payments Statement, to each student by February 1, 1999. The information on Form 1098-T will help you determine whether you can claim an education tax credit for 1998. The following information should be included on the 1998 form.

1. The name, address, and taxpayer identification number of the educational institution.
2. The name, address, and taxpayer identification number of the student.
3. Whether the student was enrolled for at least half of the full-time academic workload.
4. Whether the student was enrolled exclusively in a graduate-level program.

The eligible educational institution may ask for a completed Form W-9S, Request for Student's or Borrower's Social Security Number and Certification, or similar statement, to obtain the information needed to complete (2) above.

Illustrated Example

Dave and Valerie are married and file a joint tax return. For 1998, they claim their two children as dependents on their tax return, and their modified adjusted gross income is $72,000. Their son, Sean, will receive his bachelor's degree in psychology from the state college in May 1999. Their daughter, Corey, enrolled full-time at that same college in August 1997 to begin working on her bachelor's degree in physical education. In December 1997, Dave and Valerie paid $2,000 for each child's tuition for the winter 1998 semester. In July 1998, they paid $2,200 in tuition costs for each of them for the fall 1998 semester.

Form 8863 for Dave and Valerie

Dave and Valerie, their children, and the college meet all of the requirements for the higher education credits. Because Sean is beyond the second (sophomore) year of his postsecondary education, his expenses do not qualify for the Hope credit. But, amounts paid for Sean's expenses after June 1998 for academic periods after June 1998 qualify for the lifetime learning credit. Corey is in her first (freshman) year of postsecondary education and expenses paid for her in 1998 qualify for the Hope credit. (Payments made in 1997 are not eligible for either credit.)

Dave and Valerie figure their total higher education credits for 1998, $1,940, as shown in the completed Form 8863. They can claim the full amount because their modified adjusted gross income is not more than $80,000. They carry the amount from Form 8863 to line 44 of Form 1040, and they attach the Form 8863 to their return.

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