Dear Bonnie, My kid is going to college next year. Can you tell me something about the tax credits for higher education? I’m kind of confused. There’s the Hope Credit and the Lifetime Learning Credit. Thanks.
The American Opportunity Tax Credit, formerly known as the Hope Credit, is an education credit that has undergone a facelift – it has been enhanced in six ways between 2009 and 2012. And lucky for you, it was extended during the recent New Year’s Eve fiscal cliff tax legislation.
As the Hope credit, it was available for only the first two years of college. But thanks to the American Recovery and Reinvestment Act of 2009, the American Opportunity Tax Credit can now be used for the first four years of college. Note that any postgraduate work does not apply. However, the Lifetime Learning Credit can be used for that.
The maximum credit was originally $1,800. It is now $2,500 and may offset the alternative minimum tax, something it was not eligible for previously. And it’s now up to 40 percent refundable. In general, credits apply to an existing tax liability and if the credit is greater than the tax liability, you either lose the remainder of the credit balance or you may carry it forward to subsequent tax years. In this case however, it’s refundable. If you have no tax liability, you would still get money back. There are a handful of credits that falls into this category.
Before 2009 the Hope credit applied to tuition and fees. The new expanded version now allows the inclusion of course materials and computers. But computers can be a sticky wicket. The school must require that the student provide the computer in order to enjoy this expense toward the credit.
There are income limitations. I’ve always said that if you can afford to send your kids to college, you won’t get the credit. It’s still true. If your adjusted gross income is between $80,000-$90,000 (single or head of household) and $160,000-$180,000 (married filing joint) the credit is phased out – you don’t get the entire amount.
If you make more than the top of the range: $90,000 (single or head of household) and $180,000 (married filing joint), you don’t get the credit at all. And you cannot carry forward any unused credit to subsequent tax years.
If you fall into the income ranges where the credit is phased out completely, you may want to consider letting your child take the credit. This works if the child is working and is required to file a tax return. If you choose this option, you can’t take the child as a dependent on your own tax return. And the child cannot take his own personal exemption even though his parents are not claiming it. Usually, the credit is large enough that the resulting additional tax would be absorbed by it. The other caveat is that if the child is subject to the kiddie tax (kiddie tax is based on earnings through dividends, interest, and capital gains), the credit will be limited to his tax liability; he is not entitled to any part of the credit that is refundable.
For example: Susan is 22 and a full time student. Her parents provide more than half of her support and are entitled to take Susan as a dependent and are entitled to the American Opportunity Credit in the maximum amount of $2,500. However, their adjusted gross income is $200,000, which is $20,000 higher than the amount allowed in order to take the credit. Susan worked a part time job all year and made $10,000. Normally, she would file a tax return and check the box stating that someone else could take her as a dependent. She would pay any ensuing tax liability. However, this year, she will file on her own, and apply the credit toward any taxes owed.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, and the author of “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn’t Want You to Know.” Follow her on Twitter at BLTaxpertise and at Facebook.