Education Tax Credits Are Tools to Defer High Costs of Schooling

Now that summer has ended and students are back to school, this is a good time to remind tax practitioners that the American Opportunity Tax Credit and the Lifetime Learning Credit may be available for their clients.

First, you need to know who’s eligible. You, your spouse, or one of your dependents must be enrolled at an eligible institution—an accredited college or university or a vocational school, but not a private high school. You, your spouse, or one of your dependents also must pay for the qualified education expenses.

An education credit can’t be claimed when you’re claimed as a dependent on someone else’s return (such as your parents); you file your taxes as “married filing separately"; you claim another higher education benefit; or you were a non-resident worker during any part of the year and didn’t elect to be a resident worker.

There are income limits for claiming the credits. Your modified adjusted gross income must be $80,000 or less, or $160,000 or less if you’re married and filing jointly. The credit is phased out between $80,000 and $90,000 for single filers and between $160,000 and $180,000 for married couples filing jointly. You don’t qualify if your modified adjusted gross income is over $90,000 for singles or $180,000 for married joint filers.

The American Institute of Certified Public Accountants has suggested all education-related tax provisions have the same adjusted gross income limitations if Congress determines that phase-outs are necessary. This suggestion is part of a package aimed to simplify and harmonize higher education tax benefits that the AICPA submitted to Congress on Feb, 7, 2023.

American Opportunity Tax Credit

The AOTC is a credit for qualified education expenses paid for the first four years of higher education and replaced the Hope credit in 2009. The maximum credit available per student for each year is $2,500. If the credit lowers your tax balance due amount to zero, 40% of any remaining credit is refundable (up to $1,000).

Calculated, 100% of the credit is applied to the first $2,000 of qualified educational expenses. Thereafter, 25% is applied to the next $2,000 of qualified educational expenses, for a total of $2,500.

To be eligible for the AOTC, a student must be pursuing a degree or other recognized credential and be enrolled at least half time for one academic period in the year. The four years of higher education can’t have been finished by the beginning of the tax year.

The AOTC also can’t have been claimed for more than four years; the Hope credit can’t have been claimed for more than four years in conjunction with the AOTC. The student also must not have had a felony drug conviction.

Qualified educational expenses don’t include room and board, transportation, medical expenses, and personal expenses. The AICPA has recommended creating a uniform definition of “qualified higher education expenses” and replacing all the education incentives in the federal tax code with a single credit that’s 100% refundable and available for any six years of post-secondary education and on a per student (rather than per taxpayer) basis.

Lifetime Learning Credit

The LLC is more flexible than the AOTC, as it can be used for undergraduate, graduate, or professional degree courses. This credit also can be used for courses that can improve or help acquire job skills; the AOTC is only available for the first four years of higher education.

Another key difference is that there’s no limit on the number of years you can claim the LLC. The maximum amount you can claim is $2,000; the amount of the credit is calculated as 20% of the first $10,000 of qualified education expenses.

Students must be enrolled or taking courses at an eligible institution and be enrolled in at least one academic period per year. The course or courses also must lead to a degree or credential or lead to acquiring or improving job skills. Unlike the AOTC, the LLC is nonrefundable.

Reporting Requirements

The education credits are claimed on Form 1040, Schedule 3 and Form 8863 (educational credits).

In addition, Form 8867 (Paid Preparer’s Due Diligence Checklist) needs to be followed and completed for claiming the AOTC. Form 8867, Part IV deals specifically with the AOTC. It asks whether the taxpayer provide substantiation for the credit, such as a Form 1098-T and/or receipts for the qualified tuition and related expenses for the claimed AOTC.

Other Educational Tax Benefits

There are other educational tax incentives, such as the student loan interest deduction, tuition and fees deduction, and educational savings bonds, as well as the Coverdell Education Savings Accounts (Section 530), and qualified tuition programs (Section 529). In an effort to simplify education tax benefits, AICPA has recommended changes to these provisions.

Simplifying education-related tax provisions would allow taxpayers to better understand the rules and comply with them in a cost-efficient manner, improve the transparency and visibility of such tax provisions, and allow the monitoring of compliance with the provisions, as well as increase the benefits going to the targeted taxpayers, lower the cost of administering the tax system, and reduce the tax gap.

The IRS has several webpages that might be helpful, including Qualified Education Expenses, Education Credits: Questions and Answers Education Credits, Refundable Credits Toolkit, Compare Education Credits, and Publication 970.

There are other tools available to help fund a student’s education including scholarships, grants, federal and private student loans, and work study programs. Education credits may be smaller in scale than these options, but they shouldn’t be overlooked as educational costs continue to rise.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Eileen Reichenberg Sherr is a director of tax policy and advocacy for the American Institute of CPAs and Chartered Institute of Management Accountants, together the Association of International Certified Professional Accountants, in Washington, D.C.

Donald Zidik is a tax principal with Grassi & Co. CPAs, P.C. in Needham, Mass., and a member of AICPA’s trust, estate, and gift tax technical resource panel. He is a former member of the AICPA tax executive committee.