Education Credit or Deduction? Read between the Lines

By Ken Berry

Now that the new "fiscal cliff' tax law – officially titled the American Taxpayer Relief Act (ATRA) – has officially restored and extended several tax breaks relating to higher education, the question is: Should your clients claim a higher education tax credit or a tuition deduction for 2012? The answer? It depends.
 
As you probably know, there are two types of higher education credits available on 2012 returns, but you may not be aware of some of the subtle differences between the two. Also, the credits must be compared to the above-the-line tuition deduction. Keeping that in mind, here's a "crash course" on the 2012 tax breaks for higher education.
 
1. American Opportunity Tax Credit (AOTC): The enhanced AOTC (formerly the Hope Scholarship Credit), which was set to expire after 2012, is extended for five years by ATRA. The credit is equal to 100 percent of the first $2,000 of qualified education expenses, plus 25 percent of the next $2,000, for a maximum annual credit of $2,500 per child
 
For example, if a couple with three children in school incurred $10,000 of qualified expenses for each one, the parents can claim an AOTC of $7,500. Qualified expenses covered by the credit include tuition, mandatory enrollment fees, books, and course materials (not necessarily paid directly to the school). However, this doesn't include room and board, student health insurance, and other fees.
 

Talking Points

  • A taxpayer can claim one of two higher education credits or the tuition deduction, but not both.
  • Both of the education credits and the tuition deduction are phased out based on different MAGI levels.
  • The maximum $2,500 AOTC credit is available for each child, but the maximum $2,000 Lifetime Learning Credit isn't.
  • The definition of "qualified expenses" differs slightly for the three higher education tax breaks.
  • Taxpayers can't file a return claiming either higher education credit before mid-February, but there's no delay if the taxpayer elects the tuition deduction.
 
The AOTC is phased out based on a taxpayer's modified adjusted gross income (MAGI). For 2012 returns, the MAGI phase-out ranges are from $80,000 to $90,000 for single filers and $160,000 to $180,000 for joint filers.
 
2. Lifetime Learning Credit: Unlike the AOTC, the Lifetime Learning Credit hasn't changed in recent years. The credit is equal to 20 percent of the first $10,000 of qualified education expenses for a maximum annual credit of $2,000 per taxpayer.
 
Going back to our example, if the couple with three children in school incurred $10,000 of qualified expenses for each one, the total Lifetime Learning Credit for the parents is limited to $2,000. Therefore, the AOTC is often preferable to the Lifetime Learning Credit. Qualified expenses for the Lifetime Learning Credit include tuition, mandatory enrollment fees, books, and course materials only if required to be purchased directly from the school. Room and board and other fees don't count.
 
The Lifetime Learning Credit is also phased out based on a taxpayer's MAGI. For 2012 returns, the MAGI phase-out ranges are from $52,000 to $62,000 of MAGI for single filers and $104,000 to $124,000 for joint filers, lower than the phase-out ranges for the AOTC.
 
3. Tuition deduction: The tuition deduction technically expired after 2011, but ATRA revives it retroactive to the 2012 tax year and extends it through 2013. Generally, the deduction on 2012 returns is allowed for qualified education expenses paid last year for an academic period beginning in 2012 or in the first three months of 2013. 
 
For purposes of the tuition deduction, qualified education expenses include tuition and certain "related expenses," such as student activity fees, expenses for course-related books, and supplies and equipment only if the fees and expenses are required to be paid directly to the school. But room and board, health insurance, and other fees do not qualify for the deduction.
 
The phase-out rules for the tuition deduction are slightly different. Single filers can claim a maximum $4,000 deduction up to a MAGI of $65,000, and a maximum $2,000 deduction with MAGI of $65,000 to $80,000. Joint filers can claim the maximum $4,000 deduction up to a MAGI of $130,000, and the maximum $2,000 deduction with MAGI of $130,000 to $160,000. No deduction is allowed if the taxpayer's MAGI exceeds $160,000.
 
The IRS recently said that you can't file a return claiming one of the credits until mid-February due to changes in Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits); however, there's no such delay for filers who elect the tuition deduction. Nevertheless, if a credit produces a bigger tax benefit, it's worth waiting for the updated Form 8863. 
 
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