Be Careful With Education Credits
According to a Treasury report last month, taxpayers wrongly received nearly $3.2 billion in American Opportunity Tax Credits (AOC) between Jan. 1, 2010 and May 28, 2010. The report attributes the error to ineffective IRS procedures for the review of education credits. The Treasury has forecasted that an additional $12.8 billion in wrongfully claimed education credits will be granted over the next four years unless the current system of review is modified.
Here is a breakdown of the errors:
· $2.6 billion to 1.7 million individuals who weren’t even attending college
· $550 million went to students who didn’t attend school at least half-time or who were in graduate school, both contrary to the tax laws
· $88 million to students who were claimed as dependents on someone else’s tax return
· $256,000 to 250 prisoners with a felony conviction (IRS has to be proud of this one) J
What's really disappointing is that 52% of these returns were prepared by a paid preparer. Ouch!
Not surprisingly, the IRS has announced that they plan to review more tax returns that claim education credits.
Not surprisingly, the IRS has announced that they plan to review more tax returns that claim education credits.
So for today’s lesson I thought we should take a look at two of the main tax breaks for higher education: The American Opportunity Credit (AOC) and the Lifetime Learning Credit.
American Opportunity Credit
This is one of the better benefits if can you qualify. It is a dollar for dollar reduction in tax of up to $2,500 per student per year for up to four years of undergraduate (but not graduate) education for students enrolled at least half-time in a degree program. If you spend $4,000 in education costs, the IRS will pay you back $2,500. Since this is a per student deal, if you have more than one child in college, you can claim the credit for each one.
The credit is partially refundable, meaning even if you pay no tax you may still receive up to $1,000 back from the IRS. The credit can be used for books, supplies and equipment and tuition but if you have a felony drug conviction you are not eligible.
You have to watch your income levels. The benefit fully phases out at $90,000 of adjusted gross income (AGI) for single filers and $180,000 for married couples filing jointly. If the parent’s income is too high, you may want to run the numbers on the students return to see if they benefit by taking the credit. Just remember you cannot claim them on your return as a dependent.
Lifetime Learning Credit
The Lifetime Learning Credit is not quite as generous but still helpful. It offers a tax credit of 20% of tuition expenses, with a maximum of $2,000 on the first $10,000 of college tuition expenses. You will have to spend $10,000 on qualifying education costs to maximize the full credit. Not quite as good of a deal from the IRS.
Unlike the AOC, it applies to both graduate and undergraduate education. It can also be used for continuing education courses taken to improve job skills. There is no limit on the number of years you can take the credit. You can even take it if you have a felony conviction. Another big difference between this credit and the AOC is it’s only available per family per year. So no matter how many children you have in graduate school, you are limited to the $2,000 per year per family.
The income restrictions are even worse than the AOC, which means higher income taxpayers will not be eligible. The benefit fully phases out at $61,000 of AGI for single filers and $122,000 for married couples filing jointly.
What expenses qualify?
For purposes of both credits, qualified expenses include tuition and fees required for enrollment, course-related books, supplies and equipment. Expenses for purchasing a computer can qualify if the computer is needed for enrollment or attendance at the education institution.
Qualified expenses do not include amounts paid for insurance, medical expenses (including student health fees), transportation, room and board and other personal living expenses and student fees unless it’s a condition of enrollment.
Tip: Order a transcript from the college if you want a breakdown of expenses you paid.
Be careful with double dipping. You cannot claim both credits for the same student. Do the math and figure out which is most beneficial to you.
What if I borrow the money?
No problem. You can use money that you borrow in order to calculate the credit but you cannot claim the credit based on expenses paid with tax-free scholarship, fellowship, grant, or education savings account funds such as a Coverdell education savings account, tax-free savings bond interest or employer-provided education assistance.
Other Tax Breaks for Those Who Don’t Qualify
If you don’t qualify for these two tax credits in part because your income levels are too high, no worries. Uncle Sam offers a couple of other incentives for education that you may qualify for: Qualified tuition programs (“529 plans”) and business deductions for work related education.
Check back soon for information on how those benefits work.
If you have any comments or questions, please post them below. I would love to hear from you.
