Take advantage of changes in education credits and deductions in 2009

Many more taxpayers may be able to take advantage of education credits and deductions for 2009 because of changes enacted in American Recovery and Investment Act (the stimulus bill or ARRA) and other legislation.  One change allows families saving for college to use popular 529 plans to pay for a student's computer-related technology needs.  Under another change, using the American Opportunity credit (formerly the HOPE credit), which raises the income thresholds for eligibility, more parents and students will be able to use a federal education credit to pay part of the cost of college.  And taxpayers should remember that payments for the spring semester of 2010 made in 2009 for tuition or qualified expenses, as shown on Form 1098-T, may be used to claim either the education credits or the Tuition and Fees deduction.

Key changes in the American Opportunity Tax credit are:

* The American Opportunity Tax Credit - formerly the HOPE credit - will be available for four years (rather than two) in 2009 and 2010, for tuition and qualified expenses for qualified students

* Income phase-out levels have been raised.  The full credit is available to individual taxpayers whose modified adjusted gross income is $80,000 or less and the income limit is $160,000 for married taxpayers filing a joint return.  Married couples with MAGI of up to $180,000 and single taxpayers with MAGI of up to $90,000 will be eligible for a partial credit.

* The definition of qualified tuition and related expenses now includes expenditures for `course materials' (books, supplies, and equipment needed for a course of study). 

* The credit is now partially refundable.  Individuals who owe no taxes but who are otherwise eligible for the credit may receive up to 40 percent of the credit as a refund, not to exceed $1,000.

The American Opportunity Tax Credit is equal to 100 percent of the first $2,000 spent and 25 percent of the next $2,000, or $2,500 for a taxpayer who pays $4,000 or more in qualified expenses for an eligible student.

The American Opportunity Credit income limits are higher than for the existing Hope and lifetime learning credits. 

This credit is not available on 2008 returns that taxpayers file during 2009.

Using 529 Plans to Pay for Computer Expenses

"With many families struggling to afford college, we want every eligible taxpayer to know about their options and take advantage of all the tax breaks they can," said Internal Revenue Service Commissioner Doug Shulman.  "529 plans have become a very attractive way to save for college, and our Web section, Tax Benefits for Education is designed to help people get information about these plans."

529 plan distributions are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary.  Qualified expenses include tuition, required fees, books, supplies, equipment and special needs services.  For someone who is at least a half-time student, room and board also qualify.

For 2009 and 2010, the ARRA change adds computer technology and equipment or Internet access and related services to be used by the student while enrolled at an eligible educational institution to the list of higher education expenses which can be paid for by tax-free withdrawals from a 529 plan.  In general, expenses for computer technology are not qualified expenses for the American Opportunity credit, Hope credit, Lifetime Learning credit or Tuition and Fees deduction.

For most families who qualify, the tax savings from the American Opportunity credit exceed the tax benefits of 529 plans, says Mark Kantrowitz, publisher of FinAid, a financial aid Web site, USAToday reports. He recommends families use the credit for the first $4,000 of college expenses and use withdrawals from 529 or Coverdell plans for their remaining costs.

Lifetime Learning Credit

The Lifetime Learning education credit is helpful to graduate students who have already completed four years of higher education and to students who are only taking one course or those who are not pursuing a degree, the Internal Revenue Service says.  There is no limit on the number of years the Lifetime Learning credit can be claimed for each student.  The maximum Lifetime Learning credit is $2,000 per return per year (20 percent of qualified tuition and fees up to $10,000). 

A taxpayer cannot claim both the Hope or American Opportunity credit and Lifetime Learning credits for the same student in one year.  But if the taxpayer pays qualified education expenses for more than one student in the same year, he or she can choose to take credits on a per-student, per-year basis. 

Tuition and Fees and Student Loan Interest Deductions

Because of the increase in the income thresholds for the American Opportunity credit in 2009 and 2010, higher income taxpayers should compare the tax benefits of taking the education credit with claiming a Tuition and Fees deduction as an adjustment to income.  The taxpayer may not claim a Tuition and Fees deduction if his or her modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return), but these thresholds are similar to the American Opportunity credit income limits.  As an adjustment to income, the Tuition and Fees deduction can reduce the amount of income subject to tax by $4,000. 

The taxpayer may not take both the Tuition and Fees deduction and claim an education credit.

Interest on qualified student loans up to $2,500 can be taken as an adjustment to income by taxpayers whose modified adjusted gross income is less than $70,000 ($145,000 if filing a joint return.)

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