Education Tax Benefits (page 2)

This section describes several tax benefits for educational expenses. Other related programs, such as section 529 plans and Coverdell Education Savings Accounts, can be found in the Saving for College section. The page concerning Education Tax Benefit Coordination is also helpful when you're trying to maximize your benefits from the various education tax benefits. Additional information on these education tax benefits can be found in IRS Publication 970, Tax Benefits for Education (PDF). See also IRS Form 8863 for more information on the Hope Scholarship and Lifetime Learning tax credits.

Hope Scholarship

The Hope Scholarship provides a $1,650 tax credit per student per year for higher education expenses during the first two years of post-secondary education. (The amount increased in 2006. Previously it was up to $1,500. The amount of the Hope Scholarship is increased to $3,300 for Gulf Opportunity Zone Students.) The amount of the credit is 100% of the first $1,100 of qualified tuition and related expenses per student and 50% of the second $1,100 of qualified tuition and related expenses. The taxpayer must list the student as an exemption on their income tax return and the expenses must have been paid by the taxpayer or by the student. (Any qualified tuition and related expenses paid by the dependent are treated as though they were paid by the taxpayer, per 26 CFR 25A(g)(3).) Scholarships and financial aid do not count as qualified tuition and related expenses paid by the taxpayer. Only out-of-pocket expenses count. Gifts, bequests and inheritances do count as though paid by the taxpayer.

• The credit is allowed only for the first two tax years of higher education expenses per student. Typically the first tax year will correspond to the fall of the student's freshman year in college, and the second tax year will correspond to the spring of the freshman year and the fall of the sophomore year.
• The student must be enrolled at least half time for at least one academic period that begins during the taxable year.
• The credit is allowed only for the first two years of postsecondary education. It cannot be used if the student already has two years of post-secondary education.
• The credit will be denied for a student convicted of a felony drug offense.
• If the family has multiple students that meet the requirements, then multiple Hope Scholarship Credits may be claimed.
• The credit applies to expenses paid after December 31, 1997.
• The maximum credit per student per year is $1,650.
• You cannot use the Hope Scholarship with the Lifetime Learning tax credit for the same student in the same year, but you can use them for different students' educational expenses in the same year.
• You cannot use the Hope Scholarship and the Tuition & Fees Deduction for the same student in the same year.
• The Hope Scholarship can be used in conjunction with other tax benefits, provided that different education expenses form the basis for each benefit.
• There is an income phaseout for incomes from $45,000 to $55,000 (single filers) and $90,000 to $110,000 (married filing jointly). (These are the 2006 phaseouts. The phaseouts are indexed for inflation.) You cannot use the credit if you are married filing separate returns.

Employer Education Assistance

Your employer may provide you with up to $5,250 in employer education assistance benefits for undergraduate or graduate courses tax-free each year. The benefits must have been paid for tuition, fees, books, supplies, and equipment. Travel, lodging and meals are not included. Courses involving sports, games or hobbies are not included, unless they are required as part of a degree program or are related to the business of your employer.

Payments above $5,250 may also be tax-free, if they represent a working condition fringe benefit. This means that if you had paid for the expenses, you would have been able to deduct them as an employee business expense.

Tuition and Fees Deduction (2002-2007)

This tax benefit is also known as the Limited Deduction for Tuition Expenses or as the Torricelli Deduction.

Starting in 2002, taxpayers can deduct up to $3,000 in tuition expenses as an exclusion from income. This means you can deduct the tuition expenses even if you don't itemize deductions on schedule A of your 1040. The deduction increased to $4,000 in 2004 through 2007 and ends in 2007. The deduction is phased out for taxpayers with adjusted gross incomes of $65,000 to $80,000 (single filers) and $130,000 to $160,000 (married filing jointly). Within the phaseout income bands the amount of the deduction is reduced to $2,000. You cannot use this deduction if you claimed a tax credit for education expenses for the same student in the same year. You can use it in conjunction with tax-free distributions from Coverdell Education Savings Accounts, qualified tuition programs, and education savings bonds, provided that different education expenses form the basis for each benefit. You cannot take the deduction and use the Hope Scholarship or Lifetime Learning tax credit for the same student in the same year. If you are claimed as a dependent on someone else's tax return, you cannot use the tuition deduction. The tax deduction is only for tuition expenses paid by you. The deduction is only available for taxpayers who file IRS Form 1040.

Since this deduction is taken above the line, it can make the family eligible for additional need-based aid during the next year since it reduces AGI. That can potentially make this deduction more attractive than the Hope Scholarship or Lifetime Learning tax credit, if the additional aid is in the form of grants instead of loans.

The deduction is especially popular for families who earn too much money to qualify for the Hope Scholarship and Lifetime Learning tax credits.

The omnibus tax extender legislation passed by Congress in December 2006 extended the tuition and fees deduction for two years (2006 and 2007).

Since the legislation was passed after the IRS had already printed the 2006 federal income tax returns, there is no line on the 2006 IRS Form 1040 for reporting the deduction. Instead, taxpayers will need to include the amount of the tuition and fees deduction on line 35 "Domestic production activities deduction". Enter a "T" to the left of the amount if it includes just the tuition and fees deduction or a "B" if the amount also includes both the domestic production activities deduction and the tuition and fees deduction. If a "B" is entered, attach a breakdown to the return showing the amounts claimed for each deduction.