The Federal Education Deduction and Credits

By:
Carnet A. Brown, CPA
Published Date:
Jul 1, 2017

When it comes to credits and deductions, the primary concern of most taxpayers is the effect on their tax refunds or tax liabilities. How much will their tax refunds increase, and how much will their tax liabilities be reduced? This article focuses on the Tuition and Fees Deduction (Form 8917) and Education Credits (Form 8863). Throughout this article, the term “Education Deduction” will refer to the “Tuition and Fees Deduction,” while the term “Education Credits” will refer to the Education Credits covered by Form 8863.

There are two types of Education Credits: the American Opportunity Credit and the Lifetime Learning Credit. To claim the American Opportunity Credit, a taxpayer must obtain a Taxpayer Identification Number (TIN) by the due date on his or her 2016 tax return, which is inclusive of the extension. The credit is available for four tax years and for the first four years of a postsecondary education program that leads to a degree or other recognized education credential. To be eligible, the student must not have been convicted of a felony for possession or distribution of a controlled substance and must have been enrolled for at least half-time for one or more academic periods during the 2016 tax year or for an academic period beginning in the first three months of 2017. If an ineligible taxpayer claims the American Opportunity Credit and the act is determined to have been undertaken with reckless or intentional disregard for the rules, the taxpayer will not be allowed to claim this credit for two years. If, however, it is determined to be fraud, the taxpayer will not be able to claim this credit for 10 years.

The maximum credit available in a given year for the Lifetime Learning Credit is less than that for the American Opportunity Credit—and the conditions to qualify for the Lifetime Learning Credit are less stringent as well. The Lifetime Learning Credit is nonrefundable, and there is no limit on the number of tax years that it can be claimed for. It is also available for one or more courses, and the program does not have to lead to a degree or other recognized education credential. A student with a felony drug conviction is eligible to claim the credit, and it is available for all years of postsecondary education and for courses to acquire or improve job skills.

Before going into more detail, let’s look at the different scenarios where a taxpayer cannot claim the Education Deduction or Credits.

The Education Deduction cannot be claimed if:

  • The taxpayer’s filing status is married filing separately.
  • Another person can claim an exemption for the taxpayer as a dependent on his or her tax return, even if the other person did not claim the exemption.
  • The taxpayer’s modified adjusted gross income (MAGI) is more than $80,000 (or $160,000 for a joint return).
  • The taxpayer was a nonresident alien for part of the year and did not elect to be treated as a resident alien for tax purposes.
  • The taxpayer or someone else claimed any of the Education Credits in 2016 for qualified education expenses paid for the student.

The Education Credits cannot be claimed if:

  • The taxpayer’s filing status is married filing separately.
  • The taxpayer is claimed as a dependent by someone else—for example, on his or her parent’s tax return.
  •  The taxpayer or spouse was a nonresident alien for part of 2016 and did not elect to be treated as a resident alien for tax purposes.
  • The taxpayer’s modified adjusted gross income (MAGI) is $180,000 or more for married taxpayers filing jointly and $90,000 or more for other filing statuses (applicable to the American Opportunity Credit).
  • The taxpayer modified adjusted gross income (MAGI) is $131,000 or more for married filing jointly and $65,000 or more for other filing status (applicable to the Lifetime Learning Credit).

In order for a taxpayer to claim the Education Deduction or any of the Education Credits, the taxpayer, the taxpayer’s spouse, or a dependent claimed on their tax return must have been a student enrolled at or attending an eligible educational institution. For both the Education Deduction and the Education Credits, the amounts claimed will be based on the adjusted qualified education expenses that were paid in 2016 for an academic period beginning in 2016 or the first three months of 2017.

For tax years beginning after June 29, 2015, in order to claim the Education Deduction or the Education Credits, the law requires a Form 1098-T from a qualified educational institution unless the educational institution is not required to provide the student with a Form 1098-T. Two examples where qualified educational institutions are not required to provide Form 1098-T to students are if the student is a nonresident alien, or if the student has qualified educational expenses paid entirely with scholarships. 

Qualified education expenses comprise of tuition and fees paid by or on behalf of a student enrolled at or attending an eligible educational institution. Tuition and fees paid by a third party is treated as though they were paid by the student. Generally, tuition is always included in qualified education expenses for both the Education Deduction and the Education Credits. Fees, on the other hand, are treated differently for purposes of qualified education expenses—payments for books, supplies, or equipment used in the course of study may qualify for one of the Education Credits, but not the Education Deduction. For example, if paying these fees is a condition for enrollment or attendance, they will be included in qualified education expenses for the Education Deduction. They will, however, be included in qualified education expenses for the American Opportunity Credit whether or not the materials were purchased from the education institution. And for the Lifetime Learning Credit, they will be included only if the fees must be paid to the institution as a condition of enrollment or attendance.

Nonacademic fees, such as activity fees and athletic fees, can be included in qualified education expenses for the Education Deduction and the Education Credits only if these fees must be paid to the institution as a condition for enrollment or attendance. Personal expenses—such as room and board, insurance, or living or family expenses—are never included in qualified education expenses for either the Education Deduction or Education Credits. Other expenses excluded from qualified education expenses are any course or other education involving sports, games, or hobbies, or any noncredit course, unless such course or other education is part of the student’s degree program (this exception applies only to the Education Deduction and the Lifetime Learning Credit) or helps the student acquire or improve job skills.

Once the total qualified education expense has been determined, it will be adjusted to arrive at the adjusted qualified education expenses. For both the Education Deduction and Education Credits, the qualified education expenses for each student during each academic period should be reduced by the tax-free educational assistance allocated to the academic period. Certain tax-free educational assistance received in the following year (in this case, 2017) may be treated as a refund of qualified education expenses if it relates to qualified education expenses paid in the previous year.

The tax-free educational assistance for both the Education Deduction and the Education Credits includes  

  • the tax-free part of any scholarship or fellowship grant (including Pell Grants)
  • the tax-free part of any employer-provided educational assistance
  • veterans’ educational assistance
  • any other educational assistance that is excludable from gross income (tax-free), other than as a gift, bequest, devise, or inheritance.

For both the Education Deduction and Education Credits, refunds received after 2016 for qualified education expenses paid during 2016 but before the taxpayer income tax return is filed should be used to reduce the qualified education expenses for 2016. Refunds received after 2016 for qualified education expenses paid during 2016 but after the taxpayer income tax return is filed might need to be included in gross income in the year of receipt if the claim was for the Education Deduction. If the claim relates to the Education Credits, the taxpayer might need to repay some or all of the credit received (credit recapture). Credit recapture is achieved by reducing the qualified education expenses for 2016 by the refund, recalculating the tax liability using this new qualified expense, and then including the amount as an additional tax in 2017.

For the Education Deduction, qualified education expenses are reduced by any portion that is used to calculate the exclusion from gross income of interest received under an education savings bond program or any distribution from a Coverdell education savings account or qualified tuition program. For the Education Credits, any expenses included in the qualified education expenses must be excluded from the expenses used to determine the amount of distribution from a Qualified Tuition Program or a Coverdell ESA that is to be excluded form gross income.

Both of the Education Credits can be claimed on the same return in 2016, but not for the same student. The Education Credits also cannot be taken with the Education Deduction for the same student for the same tax year.

The maximum credit that a taxpayer can claim for the American Opportunity Credit is $2,500 for each eligible student. This means that if there are three eligible students in a given year, the taxpayer could claim $7,500 for the American Opportunity Credit. To claim the maximum credit, the adjusted qualified education expenses for each student will need to be at least $4,000. The credit is calculated as follows: 100% of the first $2,000 of qualified expenses and then 25% of the next $2,000 ($2,000 + $500 = $2,500). Forty percent of the credit is refundable, which means that the taxpayer might receive a refund even though there is no tax liability or the taxpayer is not required to file a tax return.

The maximum for the Lifetime Learning Credit is $2,000 for all eligible students. Therefore, regardless of the amount of students, the total credit will be only $2,000. To claim the maximum credit, the adjusted qualified education expenses will need to be $10,000 or more. The Lifetime Learning Credit is calculated by taking 20% of the adjusted qualified education expenses up to a maximum of $10,000. The Tuition and Fees Deduction has two maximum levels. The lower level is $2,000, and the upper level is $4,000. The lower level is for MAGI falling between $65,000 and $80,000 (between $130,000 and $160,000 if married filing jointly), and the upper level is for MAGI that is less than $65,000 ($130,000 if married filing jointly). Therefore, Tuition and Fees Deduction is allowed for qualified education expenses paid up to a maximum of $2,000 for one level and up to $4,000 for another level.

If the American Opportunity Credit is claimed, a taxpayer refund could increase by a maximum of $2,500 per eligible student or tax liability reduced by this same amount. Also, $1,000 of this amount is refundable, so it is not limited to the taxpayer liability; on the other hand, if the Lifetime Learning Credit is claimed, the effect on the taxpayer’s tax refund or tax liability would be $2,000 for all students. If the Education Deduction is claimed and the maximum deduction of $4,000 is taken, the effect on the taxpayer’s tax refund or tax liability would be $400, $600, $1,000 or $1,120 [($4,000*10%) – ($4,000*15%) – ($4,000*25%) – ($4,000*28%)]. For more information, see the instructions for Form 8917 and 8863 and Publication 970.


carnetbrownCarnet A. Brown, CPA, is an accountant at NYU Langone Health System and a member of the NYSSCPA. He is currently serving as president of the Manhattan/Bronx Chapter. He also serves on the Taxation of Individuals and Employee Benefits committees and as a delegate of the Political Action Committee. He is an affiliate of the Association of Chartered Certified Accountants (ACCA), the United Kingdom Chartered Accountant designation. Mr. Brown has more than 16 years of financial accounting and auditing experience. He can be reached at 917-569-4109 or carnet1020@yahoo.com.

 
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