Publication 17: Your Federal Income Tax; Chapter 37

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Table of Contents

What's New

Income limits increased. Beginning in 2004, the amount of your Hope or lifetime learning credit is gradually reduced (phased out) if your modified adjusted gross income (MAGI) is between $42,000 and $52,000 ($85,000 and $105,000 if you file a joint return). You cannot claim a credit if your MAGI is $52,000 or more ($105,000 or more if you file a joint return). This is an increase from the 2003 limits of $41,000 and $51,000 ($83,000 and $103,000 if filing a joint return). For more information, see Effect of the Amount of Your Income on the Amount of Your Credit, later.

Introduction

This chapter discusses two tax credits (referred to here as education credits) available to persons who pay expenses for higher education.

The Hope credit.
The lifetime learning credit.

The chapter will:

Give you general information that applies to both of the credits,
Give you specific information about each of the credits,
Help you choose which of the credits to claim, and
Show you how to figure the credit you choose.

Can you claim both education credits this year. For each student, you can elect for any year only one of the credits. For example, if you elect to take the Hope credit for a child on your 2004 tax return, you cannot, for that same child, also claim the lifetime learning credit for 2004.

If you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year, you can choose to claim either credit, but not both. For 2004, if the total qualified education expenses for a student are less than $7,500, it will generally be to your benefit to claim the Hope credit.

If you pay qualified education 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 year.

Table 37-1.Comparison of Education Credits

Hope Credit	Lifetime Learning Credit
Up to $1,500 credit per eligible student	Up to $2,000 credit per return
Available only until the first 2 years of postsecondary education are completed	Available for all years of postsecondary education and for courses to acquire or improve job skills
Available only for 2 years per eligible student	Available for an unlimited number of years
Student must be pursuing an undergraduate degree or other recognized educational credential	Student does not need to be pursuing a degree or other recognized educational credential
Student must be enrolled at least half time for at least one academic period beginning during the year	Available for one or more courses
No felony drug conviction on student's record	Felony drug conviction rule does not apply

Differences between the Hope and lifetime learning credits. There are several differences between the Hope credit and the lifetime learning credit. For example, you can claim the Hope credit based on the same student's expenses for no more than 2 years. However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. The differences between the two credits are summarized in Table 37-1.

You may be able to take a deduction for your education expenses instead of a credit. Choose the one that will give you the lower tax. See chapter 21 for details about the tuition and fees deduction.

Useful Items - You may want to see:

Publication

970 Tax Benefits for Education

Form (and Instructions)

8863
Education Credits (Hope and Lifetime Learning Credits)

Information for Both the Hope and Lifetime Learning Credits

Several rules are common to both education credits. These are discussed below.

Can You Claim a Credit

The following rules will help you determine if you are eligible to claim an education credit on your tax return.

Who Can Claim a Credit

Generally, you can claim an education credit if all three of the following requirements are met.

You pay qualified education expenses of higher education.
You pay the education expenses for an eligible student.
The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.

“Qualified education expenses” are defined below under What Expenses Qualify. “Eligible students” are defined later under Who Is an Eligible Student. A “dependent for whom you claim an exemption” is defined later under Who Can Claim a Dependent's Expenses.

You may find Figure 37-A, later in this chapter, helpful in determining if you can claim an education credit on your tax return.

Who Cannot Claim a Credit

You cannot claim an education credit for 2004 if any of the following apply.

Your filing status is married filing separately.
You are listed as a dependent in the Exemptions section on another person's tax return (such as your parents'). See Who Can Claim a Dependent's Expenses, later.
Your modified adjusted gross income (MAGI) is $52,000 or more ($105,000 or more in the case of a joint return). MAGI is explained later under Effect of the Amount of Your Income on the Amount of Your Credit.
You (or your spouse) were a nonresident alien for any part of 2004 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. More information on nonresident aliens can be found in Publication 519, U.S. Tax Guide for Aliens.
You claim a tuition and fees deduction for the same student in 2004.

What Expenses Qualify

The education credits are based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, a credit is allowed for qualified education expenses paid in 2004 for an academic period beginning in 2004 or in the first 3 months of 2005.

For example, if you paid $1,500 in December 2004 for qualified tuition for the Spring 2005 semester beginning in January 2005, you may be able to use that $1,500 in figuring your 2004 credit.

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. In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period.

Paid with borrowed funds. You can claim an education credit for qualified education expenses paid with the proceeds of a loan. You use the expenses to figure the education credit for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan payments sent directly to the educational institution as paid on the date the institution credits the student's account.

Student withdraws from class(es). You can claim an education credit for qualified education expenses not refunded when a student withdraws.

Qualified Education Expenses

For purposes of an education credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.

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.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs. See chapter 2 or 3 of Publication 970 for more information.

Related expenses. Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.

In the following examples, assume that each student is an eligible student at an eligible educational institution.

Example 1.

Jackson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified expense.

Example 2.

Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. Charles bought his books from a friend, so what he paid for them is not a qualified education expense. Donna bought hers at College W's bookstore. Although Donna paid College W directly for her first-year books and materials, her payment is not a qualified expense because the books and materials are not required to be purchased from College W for enrollment or attendance at the institution.

Example 3.

When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and the student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. Therefore, it is a qualified expense.

No Double Benefit Allowed

You cannot do any of the following.

Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim an education credit based on those same expenses.
Claim an education credit in the same year that you are claiming a tuition and fees deduction for the same student.
Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses.
Claim an education credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP).
Claim a credit based on qualified education expenses paid with tax-free scholarship, grant, or employer-provided educational assistance. See Adjustments to Qualified Education Expenses, next.

Adjustments to Qualified Education Expenses

If you pay qualified education expenses with certain tax-free funds, you cannot claim a credit for those amounts. You must reduce the qualified education expenses by the amount of any tax-free educational assistance and refund(s) you received.

Tax-free educational assistance. This includes:

Tax-free part of scholarships and fellowships (see chapter 13 of this publication and chapter 1 of Publication 970),
Pell grants (see chapter 1 of Publication 970),
Employer-provided educational assistance (see chapter 11 of Publication 970),
Veterans' educational assistance (see chapter 1 of Publication 970), and
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.

Refunds. Qualified education expenses do not include expenses for which you, or someone else who paid qualified education expenses on behalf of a student, receive a refund. For more information, see Refunds in chapters 2 and 3 of Publication 970.

Amounts that do not reduce qualified education expenses. Do not reduce qualified education expenses by amounts paid with funds the student receives as:

Payment for services, such as wages,
A loan,
A gift,
An inheritance, or
A withdrawal from the student's personal savings.

Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following situations.

The use of the money is restricted to costs of attendance (such as room and board) other than qualified education expenses.
The use of the money is not restricted and is used to pay education expenses that are not qualified (such as room and board).

Example 1.

In 2004, Jackie paid $3,000 for tuition and $5,000 for room and board at University X. The university did not require her to pay any fees in addition to her tuition in order to enroll in or attend classes. To help pay these costs, she was awarded a $2,000 scholarship and a $4,000 student loan.

The terms of the scholarship state that it may be used to pay any of Jackie's college expenses. Because she applied it toward her tuition, the scholarship is tax free. Therefore, for purposes of figuring an education credit (either Hope or lifetime learning), she must first use the $2,000 scholarship to reduce her tuition (her only qualified education expense). The student loan is not tax-free educational assistance, so she does not use it to reduce her qualified expenses. Jackie is treated as having paid $1,000 in qualified education expenses ($3,000 tuition – $2,000 scholarship) in 2004.

Example 2.

The facts are the same as in Example 1, except that Jackie uses the $2,000 scholarship to pay room and board, and, therefore, reports her entire scholarship as income on her tax return. In this case, the scholarship is allocated to expenses other than qualified education expenses. Jackie is treated as paying the entire $3,000 tuition with other funds and can figure her education credit on the entire $3,000.

Expenses That Do Not Qualify

Qualified education expenses do not include amounts paid for:

Insurance,
Medical expenses (including student health fees),
Room and board,
Transportation, or
Similar personal, living, or family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.

Sports, games, hobbies, and noncredit courses. Qualified education 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, these expenses can qualify.

Comprehensive or bundled fees. Some eligible educational institutions combine all of their fees for an academic period into one amount. If you do not receive or do not have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. The institution is required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T, Tuition Statement. See Figuring the Credit, later, for more information about Form 1098-T.

Who Can Claim a Dependent's Expenses

If there are qualified education expenses for your dependent for a year, either you or your dependent, but not both of you, can claim an education credit for your dependent's expenses for that year.

For you to claim an education credit for your dependent's expenses, you must also claim an exemption for your dependent. You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c.

IF you...	THEN only...
claim an exemption on your tax return for a dependent who is an eligible student	you can claim an education credit based on that dependent's expenses. The dependent cannot claim a credit.
do not claim an exemption on your tax return for a dependent who is an eligible student (even if entitled to the exemption)	the dependent can claim an education credit. You cannot claim a credit based on this dependent's expenses.

Expenses paid by dependent. If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid (or deemed paid) by your dependent as if you had paid them. Include these expenses when figuring the amount of your education credit.

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

Expenses paid by you. If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of an education credit. If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring an education credit.

Expenses paid by others. Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. If you claim an exemption on your tax return for the student, you are considered to have paid the expenses.

Example.

In 2004, Ms. Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. For purposes of claiming an education credit, Todd is treated as receiving the money as a gift from his grandmother and, in turn, paying his qualified education expenses himself.

Unless an exemption for Todd is claimed on someone else's return, only Todd can use the payment to claim an education credit.

If anyone, such as Todd's parents, claims an exemption for Todd on his or her tax return, whoever claims the exemption may be able to use the expenses to claim an education credit. If anyone else claims an exemption for Todd, Todd cannot claim an education credit.

Tuition reduction. When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1 of Publication 970.

Effect of the Amount of Your Income on the Amount of Your Credit

The amount of your education credit is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $42,000 and $52,000 ($85,000 and $105,000 if you file a joint return). You cannot claim an education credit if your MAGI is $52,000 or more ($105,000 or more if you file a joint return).

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form.

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 37 of that form, modified by adding back any:

Foreign earned income exclusion,
Foreign housing exclusion,
Exclusion of income for bona fide residents of American Samoa, and
Exclusion of income from Puerto Rico.

Phaseout. If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 8–14 of Form 8863.

When Must the Credit Be Repaid (Recaptured)

If, after you file your 2004 tax return, you or someone else receives tax-free educational assistance for, or a refund of, an expense you used to figure an education credit on that return, you may have to repay all or part of the credit. You must refigure your education credit(s) for 2004 as if the assistance or refund was received in 2004. Subtract the amount of the refigured credit from the amount of the credit you claimed. The result is the amount you must repay. You add the repayment (recapture) to your tax liability for the year in which you receive the assistance or refund (see the instructions for your tax return for that year). Your original 2004 tax return does not change.

Figure 37-A. Can You Claim an Education Credit for 2004?

Information for Only the Hope Credit

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

Who Is an Eligible Student

To claim the Hope credit, the student for whom you pay qualified education expenses must be an eligible student. This is a student who meets all of the following requirements.

Did not have expenses that were used to figure a Hope credit in any 2 earlier tax years.
Had not completed the first 2 years of postsecondary education (generally, the freshman and sophomore years of college) before 2004.
For at least one academic period beginning in 2004, was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.
Was free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of 2004.

Completion of first 2 years. A student who was awarded 2 years of academic credit for postsecondary work completed before 2004 has completed the first 2 years of postsecondary education. This student generally would not be an eligible student for purposes of the Hope credit.

Exception. 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.

Enrolled at least half-time. A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.

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 any of those established by the Department of Education under the Higher Education Act of 1965.

Example 1.

Marty graduated from high school in June 2003. In September, he enrolled in an undergraduate degree program at College U, and attended full time for both the 2003 Fall and 2004 Spring semesters. For the 2004 Fall semester, Marty was enrolled less than half-time. Because Marty was enrolled in an undergraduate degree program on at least a half-time basis for at least one academic period that began during 2003 and at least one academic period that began during 2004, he is an eligible student for tax years 2003 and 2004 (including the 2004 Fall semester when he enrolled at College U on less than a half-time basis).

Example 2.

After taking classes at College V on a half-time basis for the 2003 Spring and Fall semesters, Sharon became a full-time student for the 2004 Spring semester. College V classified Sharon as a second-semester sophomore for the 2004 Spring semester and as a first-semester junior for the 2004 Fall semester. Because College V did not classify Sharon as having completed the first two years of postsecondary education as of the beginning of 2004, Sharon is an eligible student for tax year 2004. Therefore, the qualified education expenses paid for the 2004 Spring semester and the 2004 Fall semester are taken into account in calculating any Hope credit for 2004.

Example 3.

During the 2003 Fall semester, Luis was a high school student who took classes on a half-time basis at College X. Luis was not enrolled as part of a degree program at College X because College X only admits students to a degree program if they have a high school diploma or equivalent. Because Luis was not enrolled in a degree program at College X during 2003, Luis was not an eligible student for tax year 2003.

Example 4.

The facts are the same as in Example 3. During the 2004 Spring semester, Luis again attended College X but not as part of a degree program. Luis graduated from high school in June 2004. For the 2004 Fall semester, Luis enrolled as a full-time student in College X as part of a degree program, and College X awarded Luis credit for his prior coursework at College X. Because Luis was enrolled in a degree program at College X for the 2004 Fall term on at least a half-time basis, Luis is an eligible student for all of tax year 2004. Therefore, the qualified education expenses paid for classes taken at College X during both the 2004 Spring semester (during which Luis was not enrolled in a degree program) and the 2004 Fall semester are taken into account in computing any Hope credit.

Example 5.

Diana graduated from high school in June 2002. In January 2003, Diana enrolled in a one-year postsecondary certificate program on a full-time basis to obtain a certificate as a travel agent. Diana completed the program in December 2003, and was awarded a certificate. In January 2004, she enrolled in a one-year postsecondary certificate program on a full-time basis to obtain a certificate as a computer programmer. Diana is an eligible student for both tax years 2003 and 2004 because she meets the degree requirement, the work load requirement, and the year of study requirement for those years.

Figuring the Credit

The amount of the Hope credit (per eligible student) is the sum of:

100% of the first $1,000 of qualified education expenses you paid for the eligible student, and
50% of the next $1,000 of qualified education expenses you paid for that student.

The maximum amount of Hope credit you can claim in 2004 is $1,500 times the number of eligible students. You can claim the full $1,500 for each eligible student for whom you paid at least $2,000 of qualified education expenses. However, the credit may be reduced based on your modified adjusted gross income (MAGI). See Effect of the Amount of Your Income on the Amount of Your Credit, earlier.

Example.

Jon and Karen Frost are married and file a joint tax return. For 2004, they claim an exemption for their dependent daughter on their tax return. Their MAGI is $70,000. Their daughter is in her sophomore (second) year of studies at the local university. Jon and Karen paid qualified education expenses of $4,300 in 2004.

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 2004. This is 100% of the first $1,000 of qualified education expenses, plus 50% of the next $1,000.

Form 1098-T. To help you figure your Hope credit, you should receive Form 1098-T. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2005.

Claiming the Credit

You claim the Hope credit by completing Parts I and III of Form 8863 and submitting it with your Form 1040 or 1040A. Enter the credit on Form 1040, line 49, or on Form 1040A, line 31. An illustrated example using Form 8863 appears at the end of this chapter.

Information for Only the Lifetime Learning Credit

You may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all students enrolled in eligible educational institutions.

Who Is an Eligible Student

For purposes of the lifetime learning credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution.

Figuring the Credit

The amount of the lifetime learning credit is 20% of the first $10,000 of qualified education expenses you paid for all eligible students. The maximum amount of lifetime learning credit you can claim for 2004 is $2,000 (20% × $10,000). However, that amount may be reduced based on your modified adjusted gross income (MAGI). See Effect of the Amount of Your Income on the Amount of Your Credit, earlier.

Example.

Bruce and Toni are married and file a joint tax return. For 2004, their MAGI is $75,000. Toni is attending a local college (an eligible educational institution) to earn credits toward a degree in nursing. She already has a bachelor's degree in history and wants to become a nurse. In August 2004, Toni paid $6,000 of qualified education expenses for her Fall 2004 semester. Bruce and Toni can claim a $1,200 (20% × $6,000) lifetime learning credit on their 2004 joint tax return.

Form 1098-T. To help you figure your lifetime learning credit, you should receive Form 1098-T. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2005.

Claiming the Credit

You claim the lifetime learning credit by completing Parts II and III of Form 8863 and submitting it with your Form 1040 or 1040A. Enter the credit on Form 1040, line 49, or Form 1040A, line 31. An illustrated example using Form 8863 is shown at the end of this chapter.

Illustrated Example

Dave and Valerie Jones are married and file a joint tax return. For 2004, they claim exemptions for their two dependent children on their tax return. Their modified adjusted gross income is $88,000. Their tax, before credits, is $9,956. Their son, Sean, will receive his bachelor's degree in psychology from the state college in May 2005. Their daughter, Corey, enrolled full-time at that same college in August 2003, to begin working on her bachelor's degree in physical education. In July 2004, Dave and Valerie paid $2,200 in tuition costs for each child for the Fall 2004 semester. In December 2004, they also paid $2,600 of tuition for each child for the Spring 2005 semester that begins in January.

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 2004 for academic periods beginning in 2004 and the first 3 months of 2005 qualify for the lifetime learning credit. Corey is in her first two (freshman and sophomore) years of postsecondary education, and expenses paid for her in 2004, for academic periods beginning in 2004 and January 2005, qualify for the Hope credit.

Dave and Valerie figure their tentative education credits for 2004, $2,460, as shown in the completed Form 8863. They cannot claim the full amount because their modified adjusted gross income is more than $85,000. They carry the amount from line 20 of Form 8863, $2,091, to line 49 of Form 1040, and they attach the Form 8863 to their return.

Form 8863 for Dave and Valerie

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Chapter 37 - Education Credits