Tax Edge

By Robert Steere, Toolkit Staff Writer

As a new school year begins, you may be turning your attention more fully to the subject of how to pay for college education for yourself, your spouse, or your children. You will want to know how our tax laws attempt to support you in your efforts. They can help in several ways

The Internal Revenue Service showed true sportsmanship when it issued a mid-year reminder in July to encourage us to take advantage of numerous tax breaks, including the new American Opportunity tax credit--the newest and largest of the tax breaks available to help parents and students cover the costs of college education. But there are other tax breaks, too, that can help lighten the financial load of college. Following is a description of several options that are available.

The American Opportunity Tax Credit. This tax credit, in reality, modifies the pre-existing Hope Scholarship credit, renaming and expanding it for 2009 and 2010. Designed to help parents and students pay part of the cost of college, the credit provides a tax break of up to $2,500. The credit is given to offset the costs of qualified education expenses--tuition, fees, books and other required course materials. A dollar-for-dollar credit is allowed for the first $2,000 of qualifying costs, and a 25 percent credit applies to the next $2,000 in costs. Significantly, up to 40 percent of the tax credit is refundable if the credit exceeds the tax liability for the year.

There are limitations on eligibility for the American Opportunity tax credit. First, the credit is phased-out once income limits are reached. If income (actually, 'modified adjusted gross income' or 'MAGI') is higher than $80,000 ($160,000 for a joint return), the maximum credit begins to phase-out. The credit can't be claimed if income is higher than $90,000 ($180,000 for a joint return). Second, the credit is only available for the first four years of college--essentially for a basic undergraduate program. Third, the credit can be claimed only by a parent if the student is claimed as a dependent on the parent's return, and only by the student if not claimed as a dependent by another person. Fourth, to be eligible for the credit, the student must be at least half-time and must be in a degree program.

This constitutes a substantial enlargement of the former Hope Scholarship credit, which, in 2008, was limited to a maximum of $1,800, covered only the costs of tuition and fees (not books and course materials), and applied only to the first two years of college. Moreover, the old law had significantly lower income limits of $48,000 ($96,000 for joint returns)for phasing-out the credit and did not provide for any of the credit to be refundable. In short, more people are eligible for more credit under the new law.

The Lifetime Learning Credit. The Lifetime Learning Credit is the next-best tax break to help defray the costs of college. The credit is calculated based on 20 percent of the costs for tuition and fees (not books or other course materials), with a maximum credit for a year of $2,000. The income limits for eligibility have not been adjusted as with the American Opportunity credit, so the 2009 income limit remains $48,000 ($96,000 for joint returns), with only an adjustment for inflation, before the credit begins to phase-out.

The Lifetime Learning credit is more flexible than the American Opportunity credit. You can claim the credit whether the student is attending full-time, part-time, or even just taking one class. The student need not be pursuing a degree. The credit can be claimed in as many years as the student takes post-secondary courses. Thus, while the income limits for eligibility are lower, the credit is more flexible and covers a greater variety of educational options.

The Tuition and Fees Deduction. If the tax credits described above can't be used for some reason, the tuition and fees deduction can be claimed to reduce your taxable income by up to $4,000. The costs of college tuition and fees (not books and other course materials) can be deducted from taxable income even if you do not itemize your deductions on your tax return. The $4,000 maximum is both a per student and per return maximum. The same income limitations apply to the tuition and fees deduction as apply to the American Opportunity credit. The deduction can be claimed only by the person who actually pays the expenses, but the rule is a bit quirky in its application. If the student pays the expenses, but can be claimed as a dependent on the parents' tax return, neither the parents nor the student are eligible for the deduction. If the parents pay the expenses, but can't claim the student as a dependent on their tax return, neither parents nor student can claim the deduction.

One Tax Break at a Time. Be clear that for each year only one of the three tax breaks above can be used with respect to the qualified education expenses of any individual student. You can't double-up on these different options--it's a one student, one tax break policy.

For more information on these tax breaks and more that can be used effectively to offset some of the costs of college, see Publication 970 on the IRS web site.

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