Publication 17
Your Federal Income Tax

For Individuals

For use in preparing 2002 Returns

36. Education Credits

Important Changes for 2002

Education credit and distribution from Coverdell ESA or QTP.   Beginning in 2002, you may be able to claim an education credit in the same year in which you receive a distribution from a Coverdell education savings account (ESA) or a qualified tuition program (QTP). However, you cannot use the same expenses to figure both the education credit and the taxable portion of a Coverdell ESA or QTP distribution. See No Double Benefit Allowed under What Expenses Qualify, later.

Income limits for credit reduction increased.   For 2002, the amount of your education credit is gradually reduced (phased out) if your modified adjusted gross income (MAGI) is between $41,000 and $51,000 ($82,000 and $102,000 if you file a joint return). You cannot claim an education credit if your MAGI is $51,000 or more ($102,000 or more if you file a joint return). The 2001 limits were $40,000 and $50,000 ($80,000 and $100,000 if filing a joint return). See Does the Amount of Your Income Affect the Amount of Your Credit, later, for more information.

Important Change for 2003

Lifetime learning credit.   Beginning in 2003, the amount of qualified tuition and related expenses you may take into account in figuring your lifetime learning credit increases from $5,000 to $10,000. The credit will equal 20% of these qualified expenses, with the maximum credit being $2,000.

Introduction

This chapter discusses two tax credits (referred to here as education credits) available to persons who pay expenses for higher education.

• The Hope credit.
• The lifetime learning credit.

The chapter will:

• Give you general information that applies to both of the credits,
• Give you specific information about each of the credits,
• Help you choose which of the credits to claim, and
• Show you how to figure the credit you choose.

Table 36-1 compares the Hope and lifetime learning credits. In 2002, if you are eligible to claim both credits based on the higher education expenses of one student, it will generally be to your benefit to claim the Hope credit.

Higher education.   This term refers to education beyond the high school level. Higher education is also called postsecondary education.

Useful Items

You may want to see:

Publication

• 970   Tax Benefits for Education

Form (and Instructions)

• 8863   Education Credits (Hope and Lifetime Learning Credits)

Rules That Apply to Both Credits

The amount of each credit is determined by the amount you pay for qualified tuition and related expenses for students, the amount of your modified adjusted gross income (MAGI), and the amount of your tax.

Education credits are nonrefundable. You subtract them directly from your tax and they may reduce your tax to zero. However, if the credits are more than your tax, the excess is not refunded to you.

Can You Claim an Education Credit?

The following rules will help you determine if you are eligible to claim an education credit on your tax return.

Who Cannot Claim a Credit?

You cannot claim an education credit if any of the following apply.

• Your filing status is married filing separately.
• You are listed as a dependent in the Exemptions section on another person's tax return (such as your parents'). See Who Can Claim a Dependent's Expenses, later.
• Your modified adjusted gross income is $51,000 or more ($102,000 or more in the case of a joint return). Modified adjusted gross income is explained later under Does the Amount of Your Income Affect the Amount of Your Credit.
• You (or your spouse) were a nonresident alien for any part of 2002 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. More information on nonresident aliens can be found in Publication 519, U.S. Tax Guide for Aliens.

Who Can Claim a Credit?

Generally, you can claim an education credit if all three of the following requirements are met.

1. You pay qualified tuition and related expenses of higher education.
2. You pay the tuition and related expenses for an eligible student.
3. The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.

Qualified tuition and related expenses are defined below under What Expenses Qualify. Eligible students are defined later under Hope Credit and Lifetime Learning Credit.

What Expenses Qualify?

The credits are based on qualified tuition and related expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, the credits are allowed for qualified tuition and related expenses paid for an academic period beginning in the same year as the year the payment is made or in the first 3 months of the following year.

For example, if you paid $2,000 in December 2002 for qualified tuition for the Spring 2003 semester beginning in January 2003, you may be able to use that $2,000 in figuring your 2002 credit.

Academic period.   An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution.

Payments with borrowed funds.   You can claim an education credit for qualified tuition and related expenses paid with the proceeds of a loan. You claim the credit in the year in which the expenses are paid, not in the year in which the loan is repaid.

Qualified Tuition and Related Expenses

In general, qualified tuition and related expenses are tuition and fees required for enrollment or attendance at an eligible educational institution.

Eligible educational institution.   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Related expenses.   Student-activity fees and fees for course-related books, supplies, and equipment are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attendance.

In the following examples, assume that each student is an eligible student at an eligible educational institution.

Example 1.   Jackson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified related expense.

Example 2.   Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. Charles bought his books from a friend, so what he paid for them is not a qualified expense. Donna bought hers at College W's bookstore. Although Donna paid College W directly for her first-year books and materials, her payment is not a qualified related expense because the books and materials are not required to be purchased from College W for enrollment or attendance at the institution.

Example 3.   When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and the student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. Therefore, it is a qualified related expense.

No Double Benefit Allowed

You cannot do any of the following.

• Deduct higher education expenses on your income tax return (for example, as a business expense or a tuition and fees deduction) and also claim an education credit based on those same expenses.
• Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses.
• Claim an education credit based on the same expenses used to figure the taxable portion of a Coverdell ESA or QTP distribution.
• Claim a credit based on expenses paid with tax-free scholarship, grant, or employer-provided educational assistance. See Adjustments to qualified expenses, next.

Adjustments to qualified expenses.   If you pay qualified higher education expenses with certain tax-free funds, you cannot claim a credit for those amounts. You must reduce the qualified expenses by the amount of any tax-free educational assistance you received.

Tax-free educational assistance could include:

• Scholarships,
• Pell grants,
• Employer-provided educational assistance,
• Veterans' educational assistance, and
• Any other nontaxable payments (other than gifts, bequests, or inheritances) received for education expenses.

Do not reduce the qualified expenses by amounts paid with the student's:

• Earnings,
• Loans,
• Gifts,
• Inheritances, and
• Personal savings.

Also, do not reduce the qualified expenses by any scholarship reported as income on the student's return or any scholarship which, by its terms, cannot be applied to qualified tuition and related expenses.

Example 1.   In 2002, Jackie paid $3,000 for tuition and $5,000 for room and board at University X. The university did not require her to pay any fees in addition to her tuition in order to enroll in or attend classes. To help pay these costs, she was awarded a $2,000 scholarship and a $4,000 student loan.

The scholarship is a qualified scholarship that is excludable from Jackie's income, and, for purposes of figuring an education credit (either Hope or lifetime learning), she must first use it to reduce her tuition (her only qualified expense). The student loan is not considered tax-free educational assistance, so she does not use it to reduce the qualified expenses. Therefore, Jackie is treated as having paid only $1,000 in qualified expenses ($3,000 tuition - $2,000 scholarship) to University X in 2002.

Example 2.   The facts are the same as in Example 1, except that Jackie reports her entire scholarship as income on her tax return. In this case, the scholarship is not treated as a qualified scholarship. Therefore, it is allocated to expenses other than qualified expenses. Jackie is treated as paying the entire $3,000 tuition to University X with other funds and can figure her education credit on the entire $3,000.

Refunds.   Qualified tuition and related expenses do not include expenses for which you receive a refund. If you paid expenses in 2002, and you receive a refund of those expenses before you file your tax return for 2002, simply reduce the amount of the expenses paid by the amount of the refund received. If you receive the refund after you file your 2002 tax return, see When Must the Credit Be Repaid (Recaptured), later.

Expenses That Do Not Qualify

Qualified tuition and related expenses do not include the cost of:

• Insurance,
• Medical expenses (including student health fees),
• Room and board,
• Transportation, or
• Similar personal, living or family expenses.

This is true even if the fee must be paid to the institution as a condition of enrollment or attendance.

Qualified tuition and related expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program or, in the case of the lifetime learning credit, is taken by the student to acquire or improve job skills, these expenses can qualify.

Who Can Claim a Dependent's Expenses?

If there are qualified higher education costs for your dependent for a year, either you or your dependent, but not both of you, can claim an education credit for that dependent's expenses for that year.

For you to claim an education credit for your dependent's expenses, you must also claim an exemption for that person. You do this by listing his or her name and other required information on line 6c, Form 1040 (or Form 1040A). (See chapter 3 for details on exemptions for dependents.)

Expenses paid by dependent.   If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid by the student as if you had paid them. Include these expenses when figuring the amount of your Hope or lifetime learning credit.

Qualified tuition and related expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent.

Expenses paid by others.   If someone other than you, your spouse, or your dependent (such as a relative or former spouse) makes a payment directly to an eligible educational institution to pay for an eligible student's qualified tuition and related expenses, the student is treated as receiving the payment from the other person. The student is treated as paying the qualified tuition and related expenses to the institution. If you claim an exemption on your tax return for the student, you are considered to have paid the expenses.

Example.   Ms. Allen makes a payment directly to an eligible educational institution in 2002 for her grandson Todd's qualified tuition and related expenses. For purposes of claiming an education credit, Todd is treated as receiving the money as a gift from his grandmother and, in turn, paying his qualified tuition and related expenses himself.

Unless an exemption for Todd is claimed on someone else's return, only Todd can use the payment to claim an education credit.

If Todd's parents, or anyone else, claims an exemption for him on their tax return, whoever claims the exemption may be able to use the expenses to claim an education credit. In this case, Todd cannot claim an education credit.

Does the Amount of Your Income Affect the Amount of Your Credit?

The amount of your education credit is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $41,000 and $51,000 ($82,000 and $102,000 if you file a joint return). You cannot claim any education credit if your MAGI is $51,000 or more ($102,000 or more if you file a joint return).

How the phaseout works.   The phaseout (reduction) works on a sliding scale. The higher your MAGI, the more your credit is reduced. You figure the reduction, if any, in Part III of Form 8863.

Modified adjusted gross income (MAGI).   For most taxpayers, MAGI is the adjusted gross income (AGI) as figured on their federal income tax return.

MAGI when using Form 1040A.   If you file Form 1040A, your MAGI is the AGI on line 22 of that form.

MAGI when using Form 1040.   If you file Form 1040, your MAGI is the AGI on line 36 of that form. If you excluded income earned abroad or from certain U.S. territories or possessions, you must increase your AGI by the following amounts.

1. Foreign earned income exclusion,
2. Foreign housing exclusion,
3. Exclusion of income for bona fide residents of American Samoa, and
4. Exclusion of income from Puerto Rico.

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