Summary of Federal Laws

Tax

Tax Issues Related to Students

Tax Credits and Tax Deductions

26 U.S.C. §25A

26 CFR 1.25A-3; 26 CFR 1.25A-4

The HOPE Scholarship Credit is one of two income tax credits for qualified tuition and related expenses added by the Taxpayer Relief Act of 1997.  The HOPE Scholarship Credit may be elected for qualified education expenses incurred during the first two years of a taxpayer’s, spouse’s, or dependent’s post-secondary education.  The credit is for up to $1,500 per year. Certain income limits apply. For tax year 2002 and beyond, the income phase-outs will be adjusted for inflation.*

• The Lifetime Learning Credit is a tax credit available for qualified tuition and related expenses incurred at any time, and is equal to 20% of up to $5,000 before 2003, and 20% of $10,000 after 2003.  The credits are phased out as adjusted gross income rises from $80,000 to $100,000 for joint filers. The credits may not be taken together.  Available for qualified tuition and related expenses paid after June 30, 1998, in taxable years ending after that date for education furnished in academic periods beginning after June 30, 1998.
  
  *Education Tax Credit Adjustments:  For 2004, the Hope and Lifetime Learning tax credits phase out ratably for taxpayers with modified AGI of $42,000 to $52,000 ($85,000 to $105,000 for joint filers).  In 2003, these figures were $41,000 to $51,000 ($83,000 to $103,000 for joint filers).
  
  

As an alternative to the HOPE and Lifetime Learning Credits, eligible taxpayers may elect to exclude from income amounts withdrawn from education IRAs.  The IRS has not clarified who controls the contributions to the education IRAs, the parents or the beneficiaries. Withdrawals from these IRAs cannot be made in the same years that taxpayers claim either the Hope Scholarship Credit, or the Lifetime Learning Credit.

Under the The Economic Growth and Tax Relief Reconciliation Act of 2001 (Pub. Law 107-16), a new alternative  will be available to those taxpayers whose adjusted gross incomes are too high to take advantage of the HOPE and Lifetime Tuition Credits.  Beginning in 2002, individual taxpayers with adjusted gross income of up to $65,000 ($130,000 for married joint filers) will be eligible for a deduction of $3,000 for higher education expenses.  The deduction amounts rise to $4,000 per year for 2004 and 2005.  In addition, in 2004 and 2005, individual taxpayers with incomes up to $80,000 ($160,00 for married joint filers) will be eligible for a deduction of $2,000.  However, all of these tax deductions are set to lapse at the end of 2005.

Final Regulations Relating to the Hope Scholarship and Lifetime Learning Credit

67 Fed. Reg. 78687, Dec. 26, 2002.

Effective Dec. 26, 2002.  This document contains amendments to the Income Tax Regulations (26 CFR part 1) regarding the Hope Scholarship Credit and the Lifetime Learning Credit (education tax credit) under section 25A of the Internal Revenue Code. The Taxpayer Relief Act of 1997 (Public Law 105-34 (111 Stat. 788) (TRA '97)) added section 25A to provide the education tax credit. In general, the education tax credit allows taxpayers to claim a nonrefundable credit against their Federal income tax for the payment of certain postsecondary educational expenses. The Economic Growth and Tax Relief Reconciliation Act of 2001 (Public Law 107-16 (115 Stat. 38)) added section 222 of the Internal Revenue Code to provide an above-the-line deduction for certain postsecondary education expenses paid in taxable years beginning after December 31, 2001, and before January 1, 2006. Section 222 is an alternative to section 25A, and taxpayers cannot claim a section 222 deduction and a section 25A education tax credit in the same year with respect to the same student.

One commentator suggested that the final regulations provide that, in the case of institutions that use clock hours or credit hours, but do not use traditional academic terms, the term academic period may include a payment period as defined by the Department of Education in 34 CFR 668.4. The final regulations adopt this recommendation.

Summary (below) of final regulations and quick recap of Hope Scholarship and Lifetime Learning Credit, courtesy of Sean P. Scally, University Counsel and Tax Attorney, Vanderbilt University.   (12/26/02)

The IRS published final regs on Hope and Lifetime Learning Educational Tax Credits Thursday, Dec 26, 2002, thereby converting the proposed regs originally proposed in Jan 1999.  You may recall these educational credits were created by the Tax Relief Act of 1997, and were first available for taxpayers on returns filed in calendar year 1998.  The Economic Growth and Tax Relief Reconciliation Act of 2001 (affectionately referred to as "EGG-TRA"), added the capability for taxpayers to take an "above-the-line" deduction for taxpayers who do not qualify for or cannot otherwise claim the Hope/Lifetime Learning Credit (LLC).  In either the deduction or the credit scenario, the benefit is phased out based upon income.  For 2002 and 03, no deduction or credit is available for individuals or joint-filers with adjusted gross income (AGI) above $65k or 130k, respectively.

By way of quick comparison, the Hope credit is available in the amount of $1,500 per STUDENT for only the first 2 years of postsecondary education. Among other requirements, the student must be pursuing a degree or other educational "credential" (such as a certificate program) and be enrolled at least half time for at least one academic period during the calendar year.The LLC, on the other hand, is available in the amount of $1k per RETURN for any postsecondary education for an unlimited period; nor does the student need to be pursuing a degree/credential and it is available for one or more courses.  The credits are mutually exclusive for the same student in the same tax year (no double dipping).  A surprising good description/comparison can be found in IRS Pub. 970, Tax Benefits for Higher Education.

Both the Hope and LLC educational tax credits appear in IRC 25A (IRC 25 contains the all-important home mortgage interest deduction) and the proposed regs mostly dealt with the calculation of the credits.  The final regs contain no surprises, but elaborate and clarify the mechanics of the credits.  For example, the final regs continue the "qualified expense" definition (which includes fees for books, supplies and equipment if required by institution for enrollment or attendance, including student health fees BUT otherwise required fees, e.g., "transportation," will not be considered "qualified" expenses).  There is further clarification on the "combined charge/allocation rule" when institutions bundle fees which include qualified and personal expenses.  Treas. Reg. 1.25A-2(d)(4). There is also clarification on the timing aspect of the credits.  For example, if qualified expenses are paid with loan proceeds and the loan amount is paid directly to an educational institution, the amount is treated as "paid" when those proceeds are actually credited to the student's account.  If the date is unknown, the default date would be when the last date for payment is required by the institution.  In addition, no credit is allowed in a tuition reduction arrangement for an employee unless the amount of the tuition reduction was actually included in the employee's gross income (in other words, as if the employee actually paid for the tuition expense.  Also, a scholarship/fellowship arrangement excluded from gross income under IRC 117 will not be eligible for Hope/LLC treatment.  There is also clarification (by use of new examples in the final regs) on how the credits apply to specific situations (e.g., a taxpayer could claim the credit for 2 one-year certificate programs in lieu of the Hope "first two years" of postsecondary education restriction). The final Regs (T.D. 9034) can be found at the Tax Analysts website (Doc 2002-28039; 2002 TNT 248-5) with a brief summary. 

Online Resources: 

Student’s Guide to Federal Income Tax (IRS Publication 4)

Tax Benefits for Higher Education (IRS Publication 970)

Revised 7/25/01 to change title, add information on 2001 tax law, and add links to IRS publications.

Updated 1/2/03 to add final regulations and summary by Sean P. Scally.

updated 10/28/03 to add information on 2004 $ amounts
links updated 6/26/08 rab
CFR updated 11/18/08 rab