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If you have children in college, you know how expensive putting a child through school can be. Fortunately, the U.S. tax code may provide you some relief — in the form of the American Opportunity and Lifetime Learning credits.
How the Credits Work
The American Opportunity credit (formerly known as the “Hope” credit) has been extended through 2017. Many of those eligible may qualify for the maximum annual credit of $2,500 per student (100% of the first $2,000 of qualifying expenses and 25% of the next $2,000 of qualifying expenses). The expenses must be for the first four years of a postsecondary education.
The full credit is available to individuals whose modified adjusted gross income (MAGI) is up to $80,000, or $160,000 for married couples filing a joint return. The credit begins to phase out for taxpayers with incomes above these levels.
Another tax credit, known as the Lifetime Learning credit, also can help parents and students pay for postsecondary education. If you meet the requirements, you may be able to claim the credit of up to $2,000 per tax return. However, not only is the maximum credit lower than that of the American Opportunity credit, but so is the phaseout range: The full credit is available to individuals whose MAGI is up to $54,000, or $108,000 for married couples filing jointly.
The good news: There’s no limit on the number of years the credit can be claimed for each student.
You can’t claim both the Lifetime Learning credit and the American Opportunity credit for the same student in one year. However, if you pay qualified education expenses for more than one student in the same year, you can claim the American Opportunity credit for one student and the Lifetime Learning credit for another student in the same year.
If you’re eligible for both credits for a student, the American Opportunity credit will likely provide the greater benefit because it can save you as much as $2,500 in federal income taxes compared with the maximum Lifetime Learning credit savings of $2,000.
If you’re paying for a fifth or later year of college or for graduate school or continuing education expenses, only the Lifetime Learning credit can potentially provide a benefit.
If your income disqualifies you from claiming these credits, your children may claim payment of the education expenses on their income tax returns and may be able to take advantage of a credit — as long as you don’t claim them as dependents. In many cases, the tax benefits to children outweigh the value of the dependency exemption to their parents.
One reason is that a credit reduces taxes dollar-for-dollar, while an exemption reduces only the amount of income that’s subject to tax. Another is that an income-based phaseout may reduce or eliminate the benefit of your exemption even if you did claim your children as dependents.
The phaseout reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately). The 2014 AGI thresholds are $254,200 (singles), $279,650 (heads of households), $305,050 (married filing jointly) and $152,525 (married filing separately).
If your exemption isn’t phased out or is only partially phased out, you’ll need to determine whether the savings you’d receive from the exemption or the savings your child would receive from the credit would save your family more taxes overall. If your exemption is fully phased out, it probably will make sense to not claim your child as a dependent so he or she can claim an education credit.
Work with a Tax Advisor
Whether you are just now sending your kids to college, or you want to go back to school yourself, the American Opportunity and Lifetime Learning credits may help you foot the bill. Contact your tax advisor for more information.