Publication 970
Tax Benefits for Education

For use in preparing 2002 Returns

1. Hope Credit

Important Changes for 2002

Hope credit and distribution from Coverdell ESA or QTP.   Beginning in 2002, you may be able to claim a Hope credit in the same year in which you receive a distribution from either a Coverdell education savings account (ESA), formerly called an education IRA, or a qualified tuition program (QTP). However, you cannot use the same expenses to figure both the Hope 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 Hope credit is 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 a Hope credit if your MAGI is $51,000 or more ($102,000 or more if you file a joint return). This is an increase from the 2001 limits of $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.

Introduction

The Hope and lifetime learning credits may be available to you if you pay higher education costs.

The lifetime learning credit is discussed in chapter 2.

This chapter explains:

• Who can claim the Hope credit,
• What expenses qualify for the credit,
• Who is an eligible student,
• Who can claim a dependent's expenses,
• How the credit is figured,
• How the credit is claimed, and
• When the credit must be repaid.

What is the tax benefit of the Hope credit?   You may be able to claim a Hope credit of up to $1,500 for qualified tuition and related expenses paid for each eligible student.

A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself.

The Hope credit you are allowed may be limited by the amount of your income and the amount of your tax.

Can you claim both education tax credits this year?   For each student, you can elect for any year only one of the credits. For example, if you elect to take the Hope credit for a child on your 2002 tax return, you cannot, for that same child, also claim the lifetime learning credit for 2002.

Tax credit for one student.   You can claim the Hope credit for a year based on the tuition and expenses of a student only if that student has not completed the first 2 years of postsecondary education (generally the freshman and sophomore years) at an eligible educational institution before the beginning of that year. Although it may take longer than 2 calendar years for a student to complete the freshman and sophomore years, you cannot claim the Hope credit based on the tuition and expenses of the same student more than twice.

The lifetime learning credit is not subject to either of these limits. This credit, based on the tuition and expenses of a student, may be claimed regardless of the amount of postsecondary education the student has completed and for an unlimited number of years for the same student. If a student qualifies for both the Hope and the lifetime learning credits for the same year, you may claim either credit, but not both.

Tax credits for more than one student.   If you pay qualified expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. This means that, for example, you can claim the Hope credit for one student and the lifetime learning credit for another student in the same year.

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

Can You Claim the Credit?

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

Who Cannot Claim the Credit?

You cannot claim the Hope 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.
• You claim the lifetime learning credit for the same student in 2002.

Who Can Claim the Credit?

Generally, you can claim the Hope 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 Who Is an Eligible Student.

What Expenses Qualify?

The Hope credit is 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 credit is allowed for qualified tuition and related expenses paid in 2002 for an academic period beginning in 2002 or in the first 3 months of 2003.

For example, if you paid $1,500 in December 2002 for qualified tuition for the Spring 2003 semester beginning in January 2003, you may be able to use that $1,500 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 a Hope credit for qualified tuition and related expenses paid with the proceeds of a loan. You use the expenses to figure the Hope credit for the year in which the expenses are paid, not 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 (as, for example, a business expense or a tuition and fees deduction) and also claim a Hope credit based on those same expenses.
• Claim a Hope credit and a lifetime learning credit based on the same qualified higher education expenses.
• Claim a Hope credit based on the same expenses used to figure the taxable portion of a Coverdell ESA or QTP distribution. See Coordination With Hope and Lifetime Learning Credits in chapter 5 (Coverdell ESA) and chapter 6 (QTP).
• 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, these expenses can qualify.

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