Ines Zemelman, EASep-05-2016
This article will explain the Lifetime Learning Credit, rules for who is eligible for the credit, what expenses qualify, the value of the credit, limitations on claiming the credit, and how the credit is claimed on your Form 1040 (including related tax schedules).
Eligibility For the Lifetime Learning Credit
Eligibility for these tax credits includes yourself, spouse, or any dependents that are claimed as exemptions on your taxes. It does not matter whether or not the student paid the expenses themselves - any expenses paid for the student, regardless of who paid, are considered as the student having paid the expenses themselves. So, the student can claim the AOC on their tax return even if the expenses were paid by someone else.
If another taxpayer (such as a parent) wants to claim it, then the student has to be a dependent for their return. Consequently, if another taxpayer does not claim the student to be a dependent, then the student is the only person who is eligible to claim the tax credit (regardless of who actually paid the expenses).
In a situation where the tax credit can be claimed by both another taxpayer as well as the student, it stands to reason that the credit should be used by whoever gains the most savings on their taxes. The taxpayers who paid the expenses must file joint returns if they were married as of the completion of the year. But, if they separate and one of them files their return as head of household, then that person can claim the tax credit. Filing status Married Filing Separately is automatically disqualified from any education credits. A taxpayer can’t claim both the Lifetime Learning Credit and American Opportunity Credit for a student during the same tax year.
There is no limit to the number of years a taxpayer can claim the Lifetime Learning Credit (although the American Opportunity Credit does have a 4 year limit). The LTC applies to both part time and full time post-undergraduate classes at qualified institutions. Continuing education and graduate classes (both degree and nondegree) to acquire or improve job skills are included. Even hobby related or sports activities can be included if they are a part of a degree program & improve job skills, or help acquire skills.
Expenses That Qualify The Lifetime Learning Credit
Expenses qualifying for the tax credit include both fees and tuition (less any grants and scholarships) that are reported using Form 1098T, equipment, supplies, and books required to take the classes. Required equipment needs to be bought from the institution itself. Note that room & board does not qualify as an expense eligible for the credit. It is also required that qualifying expenses are reduced by any tax free benefit paid by the employer, any veterans assistance for education, and generally any other amount that is excluded from income (tax free) besides inheritance, bequests, gifts, and devices.
It is acceptable for expenses to be paid out of Coverdell ESAs as well as Section 529 accounts, and from borrowed money. If a lender sends money to the educational institution directly, the student account must be credited before the funds are considered paid. If an amount is prepaid for the period starting January 1 - March 15 of the following year, the credit is taken during the tax year the course is taken. A case recently before the IRS Tax Court (Lucas Matthew McCarville, TC Summary Opinion 2016-14) ruled that expenses a student paid during December of 2011 for classes beginning in February of 2012 are disallowed for the 2011 tax year. Also, prepaid amounts for classes beginning later than March 15 in the following year are not eligible for the credit at all.
If the taxpayer claims an educational expense deduction on their Schedule A or C, they cannot also claim this credit.
The Lifetime Learning Credit is twenty percent of a maximum of ten thousand dollars of qualifying expenses. It cannot exceed the amount of tax due (i.e., it isn’t refundable), and unused credit is not allowed to carry forward. A taxpayer can’t claim both the Lifetime Learning Credit and American Opportunity Credit for a student during the same tax year. Obviously, if one can claim both of the credits, it is best to use the credit that leads to the greatest savings to the taxpayer. This tax credit phases out between USD 55,000 & USD 65,000 of Modified Adjusted Gross Income (MAGI) (between USD 110,000 & USD 130,000 if married filing jointly). The tax credit reaches zero after USD 65,000 of MAGI (USD 130,000 if married filing jointly).
Entering the Data for the Credit on Tax Returns
The supporting schedules for Form 8863 are in most tax preparation software. The supporting schedules help determine eligibility for the tax credit, the amount and type of the expenses, and the particular credit that is being claimed (LTC or AOC). These tax prep programs will usually help determine whether the credit or a deduction will provide the most benefit, and will calculate the total allowed amount.
If the taxpayer can claim the credit, the software will fill out Form 8863 for the return. Form 8863 is required to be attached. Supporting schedules are not required to get attached to the tax return, but it is recommended that they are. The allowable Lifetime Learning Credit will be shown on Form 8863 based on data on supporting schedules and MAGI. This allowable amount goes on Line 68 of Form 1040 (Line 44 on Form 1040A).
Recapture of the Lifetime Learning Credit
If a refund is received for tax free education assistance in the year after the tax return is filed claiming the credit, the excess credit amount must be paid back (recaptured). This is done by showing the amount of excess credit on the return for the tax year the refund was received. The amount of the excess gets computed by recalculating the credit using the amount of the expenses after the refund, and subtracting that amount from the amount claimed originally.
Tips for Fellowships, Scholarships, and Pell Grants
Fellowships, scholarships, and Pell Grants reduce the amount of allowable expenses for education, but it is possible to avoid the situation using careful planning. According to the Form 8863 instructions from the IRS, scholarships, fellowships, and grants are not considered tax free if the student chooses to include that amount in their income, or if these amounts were applied to costs (such as room & board) that are not considered qualified expenses.
If educational assistance is included in income, the credit for education might be increased. The grant or scholarship must be tax free, along with being allowed to be used to pay expenses besides fees and tuition (even if it is applied to fees and tuition by the school). If they elect to do this, the student is required to include the amount paid for other expenses in their income. This increases the credit by applying expenses not actually paid by assistance programs to be considered qualifying educational expenses.
Withdrawals from Coverdell ESAs and Section 529 accounts, just like scholarships and Pell grants, can be used for education expenses however the student or taxpayer desires. Credits can be taken in the same year the distributions are taken, but both can’t be used for a student during the same tax year.
As long as it wasn’t for room & board, refunds received in the year the expenses got paid reduce the amount of eligible expenses. Room & board refunds have no effect because they are not considered qualifying expenses to begin with. The same applies for refunds received during the following year, but prior to filing of the return. If a student gets a refund in the tax year following the year the return gets filed, the appropriate amount must be repaid.