Though a precious commodity, education has become somewhat of a costly investment. The price of education today has topped the charts and even surpassed some housing prices. The “per credit” costs can add up rather quickly and as a result many aspiring students find they need additional assistance to carry the financial load.

The Federal government offers two tax credits to eligible Americans to help them carry the financial burden. These credits can help you offset the costs for your education or a dependent’s education, whether a child or a spouse.

What are tax credits?

Tax credits differ from deductions that are subtracted from your total income. Credits are dollar for dollar reductions in your taxes. If you secure a credit for $1,000, your tax will be reduced by the same amount.

The two education tax credits available for 2011 are the American Opportunity Credit and the Lifetime Learning Credit

Let’s take a look at each in more detail:

American Opportunity Credit

The American Opportunity Credit, originally the Hope Credit, is offered to taxpayers who pay for undergraduate education expenses. This credit was introduced for 2009 taxpayers and it will expire in 2012 unless Congress extends it.

Features

The American Opportunity Credit is refundable which means you can receive a cash refund if your credit exceeds your taxes. You can expect a refund up to 40% of the credit amount if the refundable portion of your credit is greater than your tax amount.

The credit you can recieve has a maximum value of $2,500 for every $4,000 spent on qualifying educational expenses. Your expenses must reach $4,000 to qualify for the full credit of $2,500.

If you spend less than $4,000 in qualifying expenses, you are still eligible for a partial credit. Partial credits will cover 100% of up to $2,000 of qualifying expenses, in addition to 25% of the next $2,000.

For example, if you incurred $3,000 of qualifying expenses, you can claim a credit of $2,250.

The first $2,000 is covered at up to 100% = $2000 credit
$3,000 – $2,000 = $1,000 left which will be credited at 25%
$1,000 x 25% (0.25) x 100 = $250 credit
$2,000 + $250 – $2,250 total credit

Remember that a portion of the credit is refundable up to 40% so if you only owe $2,000 in tax and you earn a credit of $2,250, you will receive $250 cash back. If the $250 exceeded 40% of the total credit, you would only receive 40%.

Eligibility

  • The credit is available to undergraduate students who are attending a school recognized by the U.S. Department of Education. Graduate school and single course education expenses are not covered.
  • Income limits for full credit eligibility: Your modified adjusted gross income (MAGI) must not exceed $80,000 as single, head of household, and $160,000 if married, filing jointly. Partial credits are available to taxpayers who make between $80,000 and $90,000, filing as single, head of household and those who earn between $160,000 and $180,000 filing jointly as married.
  • You must be enrolled in at least a half-time schedule.
  • You must not have any drug convictions on record.
  • You cannot be someone else’s dependent. Parents of dependent children can claim the credit. Students who are taxpayers cannot be a dependent of anyone else in order to qualify for the American Opportunity Credit.
  • If you are claiming a deduction for education expenses you are not eligible to claim the credit. You must choose one or the other. If you are eligible for both, determine which would reduce your taxes more. In most cases, the tax credit would make more sense since it automatically reduces your tax burden dollar for dollar.
  • You can only use this credit for a maximum of 4 years, which includes any years the Hope Credit was claimed as well.

The Lifetime Learning Credit

The Lifetime Learning Credit is a nonrefundable credit offered by the Federal government. With a non-refundable credit, if the credit supersedes your tax owed, this extra money will not be refunded to you.

Features

The Lifetime Learning Credit provides a maximum credit of $2,000, which is calculated as 20% of up to $10,000 in expenses. In contrast with the American Opportunity Credit, the income limits are lower at $60,000 if filing single and $120,000 if filing jointly.

Graduate students as well as undergraduates are eligible for this credit and there is no limit to the amount of years you can claim the credit. Students taking one or a few courses for job related study are also eligible for the credit.

What You Should Know

You cannot claim both credits for the same student in one year. Choose which one supplies you with the greatest financial benefit. If you are a parent of two students, you are permitted to claim one credit for one student and another credit for the other.

Qualified expenses include tuition, books, supplies and equipment as well as any enrollment fees. It does not include medical expenses, transportation, dorm and living expenses or any other personal or family costs. Note: the qualified expenses differ for each credit.

To find out more information about these credits and other benefits available for students, see IRS Publication 970: Tax Benefits for Education

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