Considerations when using education credits.

• Author: Bohrer, Paul

EXECUTIVE SUMMARY

* While the Hope and Learning Credits share many characteristics, their differences can make one more advantageous than the other, depending on the circumstances.

* Actual return preparation in accordance with Sec. 25A and the proposed regulations revealed unexpected results.

* The education credits treat a family as a single taxpaying unit to relieve it of having to plan who should pay QTREs to maximize the benefits.

Working with the Hope Scholarship and Lifetime Learning Credits, in practice, makes it clear that planning may be needed to maximize the tax benefits they offer. For example, it may be worthwhile to prepay certain education expenses, have a student include a scholarship in income or have a married couple file separately to optimize tax savings. This article explains the areas in which such planning may be needed for 1999 and offers detailed examples.

Two new education credits were first available for 1998 returns, under Sec. 25A--the Hope Scholarship Credit (Hope Credit) and the Lifetime Learning Credit (Learning Credit).(1) The former could be used for certain postsecondary education expenses paid after 1997; the latter was effective for such expenses paid after June 30,1998. Proposed regulations were issued in January 1999.(2) Preparation of 1998 tax returns in accordance with Sec. 25A and the proposed regulations revealed unexpected results when the credits were used in conjunction with the Sec. 117 scholarship, exclusion, the Sec. 162 educational expense deduction, .the Sec. 151(c) dependency exemption and married filing jointly status. This article explores some of these issues and suggests ways to maximize education credit use.

General Rules

Section 201(a) of the Taxpayer Relief Act of 1997 (TRA '97) added Sec. 25A, the Hope and Learning Credits, to benefit certain taxpayers who incur qualified higher education costs. These credits are nonrefundable and apply to "qualified tuition and related expenses" (QTREs) paid for a taxpayer, his spouse and dependents. Under Sec. 25A(f)(1) and Prop. Regs. Sec. 1.25A-2(b), QTREs include tuition and fees required for enrollment or attendance at an accredited postsecondary institution that offers credit toward an associate's, bachelor's or other recognized postsecondary credential.

Sec. 25A(g)(3) generally allows the credit(s) to the taxpayer entitled to claim the student's Sec. 151 personal exemption; most QTREs paid by a student are deemed paid by the person who claims the student's exemption. Sec. 25A(g)(2) provides exceptions for QTREs paid with scholarships, educational assistance and other payments (except gifts and inheritances) excludible from gross income. Such payments are not eligible for education credits (including payments from education individual retirement accounts). An exception also exists under Prop. Regs. Sec. 1.25A-1(g) when parents elect not to take an otherwise allowable dependency exemption. In such case, the child can claim an education credit, even though he cannot claim his own exemption.

Certain other limits apply. An education credit is generally available only for QTREs paid for academic periods beginning in the year for which the credit is claimed. However, Sec. 25A(g)(4) provides that QTREs paid during a tax year for an academic period beginning during the first three months of the following tax year are eligible for credit in the year paid. Sec. 25A(c)(2)(A) allows only one of the two education credits to be claimed for a given student's QTREs for a given year. Sec. 25A(g)(6) requires married individuals to file jointly to be eligible for an education credit.

Finally, Sec. 25A(d)(2) requires education credits to phase out at certain levels of modified adjusted gross income (MAGI).(3) For married taxpayers filing jointly, the credits phase out for MAGI between $80,000--$100,000 ($40,000--$50,000 if single).

While the Hope and Learning Credits share many characteristics, their differences can make one more advantageous than the other, depending on the circumstances.

Hope Credit

Under Sec. 25A(b), the Hope Credit is available only for QTREs paid in the first two years of postsecondary education leading toward a degree and may be claimed for as many dependents as meet the qualifications. The $1,500 maximum credit per student is computed as 100% of the first $1,000 in QTREs and 50% of the next $1,000 QTREs. Students must be enrolled during at least one academic period in the tax year and carry at least half the normal full-time load for the course of study being pursued.

Learning Credit

As defined in Sec. 25A(c), the Learning Credit is a per taxpayer credit, rather than a per student credit; thus, an eligible individual or married couple may...