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Take Advantage of the Education Tax Credits

For those with children in college, or those enrolled in college themselves, it’s important to understand the education tax credits.  With so many options available when planning for education costs and available credits it is important to review all planning strategies with a professional advisor.
With the tax year quickly coming to a close, it is important to understand the various tax incentives available to taxpayers when it comes time to filing.  One such opportunity, for those with children in college, or those enrolled in college themselves is the education tax credits.  As with everything taxes, the devil is in the details, and that includes the credits outlined below.  The education tax credits, come in two types with some different rules for each.  Hippo Tax Services would like to help you navigate these credits as education costs continue to climb and outpace inflation.  For many, the primary concern when it comes to credits is the effect it will have on their tax refund or tax amount due.  Many people think the credits are for sending their children to college, which is true, but the credits are also available to you and your spouse (if you are married) as well as to your dependents.  So even taxpayers attending school part-time may qualify for a tax credit.  Being proactive and understanding what is available will help in achieving a positive outcome.

American Opportunity Tax Credit (AOTC) – The AOTC provides a credit of up to $2,500 per year per eligible student. Generally tax credits are non-refundable meaning they can only be used to offset any tax liability the taxpayer may have for the year.  However, up to 40% of the AOTC is refundable, even when the taxpayer has no tax liability. Thus, it can result in a refund of as much as $1,000 (40% of $2,500).

The credit amount is 100% of the first $2,000 of tuition and related expenses plus 25% of the next $2,000 of qualifying expenses. The AOTC is available for four tax years and only for the first four years of post-secondary education.  The student must be enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period beginning in the tax year in which the credit is claimed.

This credit phases out for joint-filing taxpayers with modified adjusted gross income between $160,000 and $180,000, and between $80,000 and $90,000 for others.  The credit is not allowed for married taxpayers using the filing status of married filing separately.

Lifetime Learning Credit (LLC) ‒ The LLC is a non-refundable credit worth up to $2,000 per year, and there is no limit on the number of years that the LLC can be claimed.  Unlike the AOTC, there is no “half-time student” requirement and single courses can qualify.  The credit is 20% of the costs of tuition and related expenses.  However, while the AOTC is determined on a per student basis, the LLC is based upon the tax family’s qualified education expenses for the year.  If a student qualifies for the more beneficial AOTC that student’s expenses cannot also be used for the LLC.

Like the AOTC, this credit phases out for higher-income taxpayers, but unlike the AOTC, the phaseout income levels are annually adjusted for inflation.  For 2019, the LLC phases out for joint filing taxpayers with modified adjusted gross income between $116,000 and $136,000, and between $58,000 and $68,000 for others.  The credit is not allowed for taxpayers who file married filing separate returns.

Who Gets the Credit? – The credit for dependents attending college or the taxpayer (and spouse, if any) attending college will be claimed on the taxpayer’s tax return.  You may qualify for this credit even if you did not pay the tuition.  If a third party directly makes a payment to an eligible educational institution for a student’s qualified tuition and related expenses, then the student would be treated as having paid the qualified tuition and related expenses.  Furthermore, qualified tuition and related expenses paid by a student would be treated as being paid by the taxpayer if the taxpayer claims the student as a dependent.  To put it simpler, the credit flows to the return that shows the student's dependency. If independent, it flows to the student, if a dependent of another, it flows to the primary taxpayers return.

Example: If one divorced parent pays qualified tuition to a college for a child but the other parent has custody of the child (and is eligible to claim the child as a dependent), then the custodial parent is treated as having directly paid the tuition to the college and would get the credit. 

Example: If a grandparent, or someone else, pays the qualified tuition directly to the institution, then the parents, assuming they claim the student as a dependent, would be the ones qualified to claim the education credit.  This would also apply if the tuition was paid for the taxpayer or spouse.  This makes for some interesting tax planning since the tuition paid directly to an educational institution is also excluded for gift reporting or gift tax consequences, allowing individuals who wish to make gifts above the $15,000 per year per recipient limit to pay the tuition for a non-dependent child or grandchild and avoid any gift tax complications, while at the same time providing the education credit.

Qualified Tuition and Related Expenses – Recent law changes affecting qualified expenses are only applied to the AOTC, thus creating additional differences between the two credits.

  • AOTC – Qualified expenses include tuition, books, supplies, and equipment required for enrollment or attendance at an eligible institution.  These materials can be purchased from the institution or an outside vendor.  Our office can help guide you through the qualifying items when it comes time to file your tax return. 
  • LLC – Qualified expenses include tuition and amounts paid for books, supplies, and equipment, but only if these items are purchased from the educational institution as a condition of attendance.

Eligible Educational Institutions – Eligible institutions generally include any accredited public, nonprofit or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education.  This includes most colleges and universities.  Vocational schools or other post-secondary schools may also qualify 

Special Tuition Prepayment Rule – A special rule allows the tuition for an academic period that begins in the first three months of the next year to be paid in advance; thus, it increases the amount of tuition qualifying for the credit in the year when the tuition is paid.  This allows for planning of when to make tuition payments to maximize credits, especially in the first partial calendar year.

Tax Tip: Since the American Opportunity credit is only allowed in the first four tax years (calendar years for nearly all individuals) for each eligible student, taxpayers may benefit from prepaying the education expenses for an academic period beginning in the first three months of the next year.  This is especially important when you consider that most students enter college in the last half of the first tax year and qualify for the credit with only half a year’s expenses in the first year.  Working out a payment plan in which the tuition is prepaid under the three-month rule for each of the academic years would more evenly spread the tuition over the four years.

As you can see, several nuances associated with the education credits must be considered.  With so many options available when planning for education costs and available credits it is important to discuss all planning strategies with your financial advisors and CPA and to start saving for college early to take advantage of the tax incentives available.  Please call us at Hippo Tax Services to schedule a time to discuss your plans.

Please check with your Curran Wealth relationship manager,
 or contact Curran Wealth Management if you have any questions.  
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The material contained in this article is for educational and informational purposes only.  The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness.  This article is not, and should not be regarded as “investment advice” or construed as a “recommendation” or an offer to buy or sell a security.  The information contained in this article may not apply to your personal circumstances.  Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation.  Information on taxes is based on the tax laws existing at the time of publication.  Tax laws are subject to continual change.  In addition, tax laws vary by state.  This article is not, and should not be regarded as tax or legal advice.  We cannot ensure tax consequences of any transaction.  If you would like a detailed analysis of your tax situation, with specific tax recommendations, you can discuss the possibility of pursuing a formal relationship with Hippo Tax Services, LLC.