Maximizing higher education tax credits
American Opportunities Credit (AOTC)
- Credit can be as much as $2,500 (dollar for dollar reduction of tax liability).
- If you have at least $4,000 of qualifying education expenses during the year, you could get the full $2,500 credit. (If your expenses are less, you could still get some of the credit.)
- Limited to the first four years of higher education expenses (i.e. college)
Lifetime Learning Credit
- Up to $2,000 (20% of qualified expenses up to $10,000)
- Can be used for expenses paid directly to a qualified university, college, vocational school, or classes needed to improve job skills
- No limit on the number of years the credit can be taken (unlike the AOTC)
When determining the amount of the credit, college expenses are put into 2 categories: (1) qualified and (2) non-qualified. Only qualified expenses will count for purposes of calculating the credit.
- Qualified Expenses = tuition and some books, supplies, and equipment
- Non-qualified Expenses = personal expenses, living expenses, room and board, transportation, and medical expenses.
- In other words, you want qualified expenses of either ($4,000 for the AOTC or $10,000 for the Lifetime Learning Credit)
- If tax free educational assistance is received (scholarships/grants/additional financial assistance), college expenses for purposes of calculating the credit must be reduced by the amount of assistance received.
Tax Planning Strategy
If the scholarship or grant allows, it may be beneficial for taxpayers to use scholarship funds to pay for non-qualified expenses and/or include portions of the scholarship as taxable income, especially given the new increased standard deduction amounts. This would result in NO reduction to qualified education expenses, thereby maximizing the potential for education tax credits.
Important things to consider are taxpayer’s filing status, other income, other credits, dependent status, phaseout limits, and which credits the taxpayer is eligible for. It is important to understand the terms of the scholarship as well. Some of the scholarships may not be eligible to cover non-qualified expenses.
For more information, read the full article from the Journal of Accountancy.