Uncle Sam wants you and your kids to go to college. In fact, he's even willing to offset your higher-education expenses with a couple of tax breaks: The lifetime learning credit and the Hope scholarship credit.
A taxpayer can claim a lifetime learning credit equal to 20% of up to $5,000 in qualifying tuition and related expenses. This credit applies to qualified expenses paid by the taxpayer for himself, his spouse, or any dependent. Therefore, the maximum Lifetime credit that can be claimed is $1,000 (20% of $5,000). The Hope scholarship credit allows qualified taxpayers to take up to a $1,500 tax credit for the payment of qualified education expenses incurred for the first two years of undergraduate education at an eligible institution.
As you can see, the credits are similar enough to be confusing, yet different enough to get people in trouble. Let's start by looking at what the two credits have in common:
- The school or college must be an eligible educational institution (including certain vocational schools).
- The credits are available only for qualified tuition and related expenses of an eligible student.
- The credits aren't allowed for an expense that was claimed as an education deduction, and also aren't allowed for any expenses paid using tax-free funds from a Coverdell Education Savings Account or 529 plan.
- The credits cannot both be claimed in the same tax year for the same expenses. But, each credit can be claimed for different expenses for different students.
- Neither credit is refundable, but either credit can be used to reduce both your regular tax and your Alternative Minimum Tax.
- The credits are not available for taxpayers who are married filing separately, or for an individual who is claimed as a dependent on another's return.
- Both credits are phased out ratably for married taxpayers filing jointly with adjusted gross income (AGI), with certain modifications, between $80,000 and $100,000. For single filers, the phase-out range is $40,000 to $50,000. The phase-out amounts will be adjusted for inflation.
So much for the similarities. There are a number of significant differences between the Hope and lifetime credits. Let's look:
- The lifetime credit covers qualified education expenses paid after June 30, 1998. In addition, these expenses must be paid for academic periods beginning after June 30, 1998. (For additional information on how the "academic period" restriction works, check out the article on the Hope credit.)
- Beginning in 2003, the amount of the lifetime credit will increase. Starting in 2003, the maximum amount of qualified tuition and expenses that can be used to determine the Lifetime credit for a tax year will increase to $10,000. So, after year 2002, the maximum credit will be $2,000 (20% of $10,000).
- While the Hope credit is only available to students in the first two years of post-secondary years of education, the lifetime credit is available to all qualified students. The lifetime credit (as the name implies) is available for any qualified education.
- There is no limit on the number of years for which the lifetime credit can be claimed.
- While the Hope credit has a "half-time" enrollment requirement, the lifetime credit does not. The lifetime credit is available for the cost of courses at an eligible educational institution, regardless whether the student is on a full-time, half-time, or less-than-half-time basis.
- The lifetime credit is available to either acquire or improve the student's job skills.
One advantage of the Hope over the lifetime credit is that the maximum amount of the lifetime credit that may be claimed on a taxpayer's return doesn't vary based on the number of students in the taxpayer's family. Therefore, unlike the Hope credit (which is computed on a per-student basis), the lifetime credit is computed on a per-family basis. Let's look at an example.
Boris and Natasha are married, with an AGI of $35,000. They pay $5,000 in tuition and expenses for Boris, and also pay $2,000 in tuition and expenses for Natasha. If they qualified for the Hope credit, they could claim a credit of $1,500 each, for a total Hope credit of $3,000. But if they don't qualify for the Hope credit, their maximum lifetime credit would amount to only $1,000, even though they may both meet the eligibility requirements and have qualifying expenses. This is because for lifetime credit purposes, the credit is determined on a per-family basis, not on a per-student basis.
As you might remember, the Hope credit is denied to any individual who has ever been convicted of a federal or state felony drug offense. There is no such denial for the Lifetime credit. Why? I have no idea. It's just one of the beautiful things about tax "simplification."
Finally, as with the Hope credit, eligibility for the lifetime learning credit is subject to a number of technical requirements not fully discussed above. While we've hit the highlights here, you might want to check with your local higher-education institution for those additional details and requirements. Or, you can drift over to the IRS website and download Publication 970.
Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.
