The Costs & Rewards of a College Education

Part 6 - Tax Incentives for Higher Education Expenses: The Hope Tax Credit

There are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. They are the Hope Credit and the Lifetime Learning Credit, also referred to as education credits.  A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself.  This week, I will be focusing on the Hope Tax Credit

Hope Tax Credit

Traditionally, the Hope credit provides a tax credit of up to 100% of the first $1,200 of qualified education expenses plus 50% of the next $1,200, per student per year.  However, in February, 2009 the American Recovery and Reinvestment Act of 2009 was passed which modified the provisions of the Hope credit.  These new provisions are explained in greater detail below and are applicable for 2009 and 2010 only.

The credit is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.  Further, the Hope credit is only available for full-time students in the first two years of post-secondary education at an eligible institution.

For purposes of the Hope credit, qualified education expenses include tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.  Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.  Expenses such as room and board, insurance, and medical expenses (including student health fees) do not qualify for the Hope credit.

Generally, the credit is allowed for qualified education expenses paid in a calendar year for an academic period beginning in that year or in the first 3 months of the following year.  For example, if you paid $2,000 in December 2008 for qualified tuition for the Spring 2009 semester beginning in January 2009, you may be able to use that $2,000 in figuring your 2008 credit.

The amount of your Hope credit for 2008 is gradually reduced (phased out) if you are filing single and your modified adjusted gross income (MAGI) is between $48,000 and $58,000 ($96,000 and $116,000 if you file a joint return). You cannot claim a credit if your MAGI is $58,000 or more ($116,000 or more if you file a joint return).  For most tax-payers, MAGI is simply their adjusted gross income (AGI) as figured on their federal income tax return.

To claim the Hope tax credit, the student for whom you pay qualified education expenses must be an eligible student. This is a student who meets all of the following requirements:

•  The student did not have expenses that were used to figure a Hope credit in any 2 earlier tax years.

• The student had not completed the first 2 years of postsecondary education (generally, the freshman and sophomore years of college) before the current calendar year.

• For at least one academic period beginning in the current calendar year, the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.

• The student has not been convicted of any federal or state felony for possessing or distributing a controlled substance as of the end of the current calendar year.

Per IRS regulations, the following actions are prohibited with the Hope Credit:

• Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim a Hope credit based on those same expenses.

• Claim a Hope credit in the same year that you are claiming a tuition and fees deduction for the same student.

• Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses.

• Claim a Hope credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP), such as a 529 plan.

• Claim a credit based on qualified education expenses paid with a tax-free scholarship, grant, or employer-provided educational assistance.

As mentioned earlier in this section, the American Recovery and Reinvestment Act of 2009 temporarily modified some of the provisions of the Hope credit.  For 2009 and 2010 the American Opportunity Tax Credit is the new name of the Hope credit program.  The new law temporarily enhances the existing Hope education credit for 2009 and 2010 only in:

• Amount – The maximum amount of the Hope Credit increases from $1,800 to $2,500 per student.

• Availability – The Hope Credit can now be claimed for the first four years of post-secondary education, and

• Phase-out level – The credit is phased out (gradually reduced) if your modified adjusted gross income (AGI) is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return).

Under the new credit, the maximum $2,500 per year would be allowed on $4,000 in qualifying payments (100 percent of the first $2,000 and 25 percent of the next $2,000). Although this credit would be made retroactive to January 1, 2009, it does not automatically apply to a college semester that begins in 2009. Tuition paid late in 2008 for an upcoming 2009 semester qualifies only for a 2008 credit under existing rules.  Further, forty percent (.40) of the Hope Credit is now a refundable credit, which means that you can receive up to $1,000 even if you owe no taxes.

Next week, I will focus on the Lifetime Learning Credit and how it can be an additional benefit for college expenses.