The following two tax credits are available to persons who pay higher education costs.

• The Hope credit.
• The lifetime learning credit.

If a student receives a tax-free withdrawal from an education IRA in a particular tax year, none of that student’s expenses can be used as the basis of a higher education credit for that tax year. However, the student can waive the tax-free treatment. See Waiver of tax-free treatment under No double benefit allowed

Rules That Apply to Both Credits

The amount of each credit is determined by the amount you pay for qualified tuition and related expenses for students and the amount of your modified adjusted gross income. Education credits are subtracted from your tax but they are nonrefundable. This means if the credits are more than your tax, the excess is not refunded to you.

If you are married filing separately you cannot claim the higher education credits.

What expenses qualify. The credits are based on qualified tuition and related expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. The credits are allowed for qualified tuition and related expenses paid for an academic period beginning in the same year as the year the payment is made (but see Prepaid expenses , later).

In general, qualified tuition and related expenses are tuition and fees required for enrollment or attendance at an eligible educational institution. Student-activity fees and fees for course-related books, supplies, and equipment are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attendance.

Prepaid expenses. If you paid qualified tuition and related expenses in 2000 for an academic period that begins in the first three months of 2001, you can use the prepaid amount in figuring your credit.

For example, if you paid $2,000 in December 2000 for qualified tuition for the winter 2001 semester beginning in January 2001, you can use that $2,000 in figuring your 2000 credit.

Payments with borrowed funds. You can claim an education credit for the qualified tuition and related expenses paid with the proceeds of a loan. The credit is claimed in the year in which the expenses are paid, not in the year in which the loan is repaid.

What expenses do not qualify. Qualified tuition and related expenses do not include the cost of insurance, medical expenses (including student health fees), room and board, transportation or similar personal, living or family expenses, even if the fee must be paid to the institution as a condition of enrollment or attendance.

Qualified tuition and related expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student’s degree program or, in the case of the lifetime learning credit, is taken by the student to acquire or improve job skills, these expenses can qualify.

Dependent for whom you claim an exemption. You claim an exemption for a dependent if you list his or her name on line 6c, Form 1040 (or Form 1040A). (See chapter 3 for details on exemptions for dependents.)

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution.

No double benefit allowed. You cannot:

• Deduct higher education expenses on your income tax return and also claim a Hope credit based on those same expenses,
• Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses, or
• Claim a credit based on expenses paid with tax-free scholarship, grant, or employer-provided educational assistance. See Adjustments to qualified expenses, next.

Adjustments to qualified expenses. If you pay higher education expenses with certain tax-free funds, you cannot claim a credit for those amounts. You must reduce the qualified expenses by the amount of any tax-free educational assistance you received. Tax-free educational assistance could include:

• Scholarships,
• Pell grants,
• Employer-provided educational assistance,
• Veterans’ educational assistance, and
• Any other nontaxable payments (other than gifts, bequests, or inheritances) received for educational expenses.

Do not reduce the qualified expenses by amounts paid with the student’s:

• Earnings,
• Loans,
• Gifts,
• Inheritances, and
• Personal savings.

Also, do not reduce the qualified expenses by any scholarship reported as income on the student’s return or any scholarship which, by its terms, cannot be applied to qualified tuition and related expenses.

Waiver of tax-free treatment. The designated beneficiary of an education IRA can waive the tax-free treatment of the withdrawal and elect to pay any tax that would otherwise be owed on the withdrawal. The beneficiary or the beneficiary’s parents may then be eligible to claim a Hope credit or lifetime learning credit for qualified higher education expenses paid in that tax year. See Education IRAs in Publication 970.

Refunds. Qualified tuition and related expenses do not include expenses for which you receive a refund. If you paid expenses in 2000, and you received a refund of those expenses in 2000 or 2001, but before you file your tax return for 2000, simply reduce the amount of the expenses by the amount of the refund received. If you receive the refund after you file your tax return, see Recapture of credit , next.

Recapture of credit. If, after you file your 2000 tax return, you receive tax-free educational assistance for, or a refund of, an expense you used to figure a higher education credit, you may have to recapture all or part of the credit. You must refigure your education credits as if the assistance or refund was received in 2000. Subtract the amount of the refigured credit from the amount of the credit you claimed. See the instructions for the 2000 tax return for information about how and where to report the recapture.

Who can claim the credit. If there are higher education costs for your dependent child, either you or your child, but not both of you, can claim a credit for a particular year. If you claim an exemption for your child on your tax return, only you can claim a credit. If you do not claim an exemption for your child on your tax return, only your child can claim a credit.

Expenses paid by others. If someone other than you, your spouse, or your dependent (such as a relative or former spouse) makes a payment directly to an eligible educational institution to pay for a student’s qualified tuition and related expenses, the student is treated as receiving the payment from the other person. The student is treated as paying the qualified tuition and related expenses to the institution. If the student is your dependent, you are considered to have paid the expenses.

Example. Ms. Allen makes a payment directly to an eligible educational institution in 2000 for her grandson Todd’s qualified tuition and related expenses. For purposes of claiming an education credit, Todd is treated as receiving the money from Ms. Allen and, in turn, paying his qualified tuition and related expenses himself.

If Todd is not listed as a dependent on anyone’s return, he can use the payment to claim an education credit.

If anyone, such as his parents, lists him as a dependent on their tax return, whoever lists him as a dependent may be able to use the expenses to claim an education credit.

Expenses paid by dependent. If you claim an exemption for the student on your tax return, treat any expenses paid by the student as if you had paid them. Include these expenses when figuring the amount of your Hope or lifetime learning credit.

Qualified tuition and related expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent.

Nonresident alien. You cannot claim an education credit if you (or your spouse) were a nonresident alien for any part of 2000, and the nonresident alien did not elect to be treated as a resident alien.

Income Phaseout

Your education credits are phased out (gradually reduced) if your modified adjusted gross income is between $40,000 and $50,000 ($80,000 and $100,000 if you file a joint return).

You cannot claim any higher education credits if your modified adjusted gross income is $50,000 or more ($100,000 or more if you file a joint return).

Modified adjusted gross income. For most taxpayers, modified adjusted gross income will be their adjusted gross income (AGI) as figured on their federal income tax return. On Form 1040, AGI is line 34. On Form 1040A, AGI is line 19. However, you must make adjustments to your AGI if you excluded income earned abroad or from certain U.S. territories or possessions. If this applies to you, increase your AGI by the following amounts you excluded from your income.

1. Foreign earned income of U.S. citizens or residents living abroad.
2. Housing costs of U.S. citizens or residents living abroad.
3. Income from sources within Puerto Rico, Guam, American Samoa, or the Northern Mariana Islands.

How the phaseout works. The phaseout (reduction) works on a sliding scale. The higher your modified adjusted gross income, the more your credits are reduced. You figure the reduction, if any, in Part III of Form 8863.

Hope Credit

You may be able to claim a Hope credit of up to $1,500 for qualified tuition and related expenses paid for each eligible student.

Eligible student for the Hope credit. You can claim a Hope credit only for an eligible student who meets all of the following requirements.

1. Did not have expenses that were used to figure a Hope credit in any 2 earlier years.
2. Had not completed the first 2 years of postsecondary education (generally, the freshman and sophomore years of college).
3. Was enrolled at least half-time in a program that leads to a degree, certificate, or other recognized educational credential, for at least one academic period beginning in 2000.
4. Was free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of 2000.

Completion of first 2 years. A student awarded 2 years of academic credit for postsecondary work completed prior to the beginning of the year has completed the first 2 years of postsecondary education.

Any academic credit awarded solely on the basis of the student’s performance on proficiency examinations is disregarded in determining whether the student has completed 2 years of postsecondary education.

Half of normal full-time workload. The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than standards for half-time established by the Department of Education under the Higher Education Act of 1965.

Amount of credit. The amount of the Hope credit is 100% of the first $1,000 plus 50% of the next $1,000 you pay for each eligible student’s qualified tuition and related expenses. The maximum amount of Hope credit you can claim in 2000 is $1,500 times the number of eligible students. You can claim the full $1,500 for each eligible student for whom you pay at least $2,000 for qualified expenses. However, the credit may be reduced based on your modified adjusted gross income. See Income Phaseout, earlier.

Example. Jon and Karen are married and file a joint tax return. For 2000, they claim an exemption for their dependent daughter on their tax return and their modified adjusted gross income is $70,000. Their daughter is in her sophomore (second) year of studies at the local university and Jon and Karen pay qualified tuition and related expenses of $4,300 in 2000.

Jon and Karen, their daughter, and the local university meet all of the requirements for the Hope credit. Jon and Karen can claim a $1,500 Hope credit in 2000. This is the maximum amount allowed for 2000.

How to figure the Hope credit. The Hope credit is figured in Parts I and III of Form 8863. An illustrated example using Form 8863 appears later.

Lifetime Learning Credit

You may be able to claim a lifetime learning credit of up to $1,000 for qualified tuition and related expenses paid for all students enrolled in eligible educational institutions.

The lifetime learning credit is different than the Hope credit in the following ways.

1. The lifetime learning credit is not based on the student’s work load. It is allowed for one or more courses.
2. The lifetime learning credit is not limited to students in the first 2 years of postsecondary education.
3. Expenses for graduate-level degree work are eligible.
4. Expenses related to a course of instruction or other education that involves sports, games, hobbies, or other noncredit courses are eligible if they are part of a course of instruction to acquire or improve job skills.
5. There is no limit on the number of years for which the lifetime learning credit can be claimed for each student.
6. The amount you can claim as a lifetime learning credit does not vary (increase) based on the number of students for whom you pay qualified expenses.

Amount of credit. The amount of the lifetime learning credit is 20% of the first $5,000 of qualified tuition and related expenses you pay for all eligible students. The maximum amount of lifetime learning credit you can claim for 2000 is $1,000 (20% × $5,000). However, that amount may be reduced based on your modified adjusted gross income. See Income Phaseout, earlier.

Example. Bruce and Toni are married and file a joint tax return. For 2000, their modified adjusted gross income is $50,000. Toni is attending the community college (an eligible educational institution) to earn credits towards an associate’s degree in nursing; she already has a bachelor’s degree in history and wants to become a nurse. In August 2000, Toni paid $2,000 for her fall 2000 semester. Bruce and Toni can claim a $400 (20% × $2,000) lifetime learning credit on their 2000 joint tax return.

How to figure the lifetime learning credit. The lifetime learning credit is figured in Parts II and III of Form 8863. An illustrated example using Form 8863 appears later.

Choosing Which Credit To Claim

For each student, you can elect for any tax year only one of the credits or a tax-free withdrawal from an education IRA. (See Education IRAs in chapter 18 for more information.) For example, if you elect to take the Hope credit for a child on your 2000 tax return, you cannot, for that same child, also claim the lifetime learning credit for 2000 or take a tax-free withdrawal from an education IRA for 2000.

Lifetime learning credit after Hope credit. You can claim the Hope credit for the first 2 years of a student’s postsecondary education and claim the lifetime learning credit for that same student in later tax years.

More than one student. If you pay qualified expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. This means that, for example, you can claim the Hope credit for one student and the lifetime learning credit for another student in the same tax year.

How To Claim the Credits

You elect to claim education credits and you figure their amount by completing Form 8863. Use Part I for the Hope credit and Part II for the lifetime learning credit. In both parts, you enter the student’s name and taxpayer identification number (usually a social security number) and the amount of qualified expenses paid in 2000. You then complete Part III to compute the amount to enter on line 46 of Form 1040 or line 29 of Form 1040A. Attach the completed Form 8863 to your return.

An eligible educational institution (such as a college or university) that receives payment of qualified tuition and related expenses should issue Form 1098-T , Tuition Payments Statement, to each student by February 1, 2001. The information on Form 1098-T will help you determine whether you can claim an education tax credit for 2000. The following information should be included on the 2000 form.

1. The name, address, and taxpayer identification number of the educational institution.
2. The name, address, and taxpayer identification number of the student.
3. Whether the student was enrolled for at least half of the full-time academic workload.
4. Whether the student was enrolled exclusively in a graduate-level program.

The eligible educational institution may ask for a completed Form W-9S , Request for Student’s or Borrower’s Social Security Number and Certification, or similar statement, to obtain the information needed to complete (2) above.

Illustrated Example

Dave and Valerie are married and file a joint tax return. For 2000, they claim exemptions for their two dependent children on their tax return, and their modified adjusted gross income is $72,000. Their son, Sean, will receive his bachelor’s degree in psychology from the state college in May 2001. Their daughter, Corey, enrolled full-time at that same college in August 1999 to begin working on her bachelor’s degree in physical education. In December 1999, Dave and Valerie paid $2,000 for each child’s tuition for the winter 2000 semester. In July 2000, they paid $2,200 in tuition costs for each of them for the fall 2000 semester. Form 8863 for Dave and Valerie

Dave and Valerie, their children, and the college meet all of the requirements for the higher education credits. Because Sean is beyond the second (sophomore) year of his postsecondary education, his expenses do not qualify for the Hope credit. But, amounts paid for Sean’s expenses in 2000 for academic periods after 1999 and before April 1, 2001, qualify for the lifetime learning credit. Corey is in her first (freshman) year of postsecondary education and expenses paid for her in 2000 for academic periods beginning after 1999 and before April 1, 2001, qualify for the Hope credit.

Dave and Valerie figure their total higher education credits for 2000, $1,940, as shown in the completed Form 8863. They can claim the full amount because their modified adjusted gross income is not more than $80,000. They carry the amount from Form 8863 to line 46 of Form 1040, and they attach the Form 8863 to their return.

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