Last week we reviewed the new laws regarding the "above the line" deduction for qualified student loan interest. But this is only a small part of the education tax breaks that were provided in the 1997 Taxpayer Relief Act. Two other major education provisions include the HOPE credit and the Lifetime Learning Credit. These two credits are somewhat similar and are often discussed at the same time. But we'll break them down separately here. This week we'll discuss the HOPE credit.
The HOPE (not another government acronym, simply short for the entire title: The Hope Scholarship Credit) credit may allow you to turn part of the higher education expenses you pay for yourself, your spouse, or your dependents into tax savings.
The maximum HOPE credit a taxpayer may claim is $1,500 per year per student for the first two years of undergraduate education at an eligible educational institution. The credit equals the sum of:
- 100% of the first $1,000 of qualified tuition and related expenses paid, plus
- 50% of the next $1,000 of qualified tuition and related expenses paid.
Therefore, as you can see, the maximum credit for an eligible student for any tax year is $1,500. Be aware that the maximum HOPE credit amount will be adjusted for inflation after year 2001. And be aware, in case you just skimmed over it the first time, the HOPE credit is only available for the first two years of undergraduate education at an eligible educational institution. So this credit isn't for everybody.
Generally, eligible educational institutions are accredited schools offering credit toward a bachelor's or associate's degree or other recognized post-high school credential, and certain vocational schools.
The HOPE credit is available only for the qualified tuition and related expenses of an eligible student, i.e., a student who is enrolled in a degree or certificate program on at least a half-time basis at an eligible educational institution. In addition, the HOPE credit will be denied to any individual who has ever been convicted of a federal or state felony drug offense.
The HOPE credit isn't allowed for an expense that's claimed as an education deduction, and may not be claimed in a year when the student receives any tax-exempt distribution from an education individual retirement account (that is, an education IRA. We'll talk about education IRAs in more detail in an upcoming report).
Additionally, you should know that the HOPE and Lifetime Learning credits may not be claimed in the same tax year for the same expenses, but each may be claimed for different expenses.
In order to be eligible for the HOPE credit, qualified tuition and related expenses must be paid during that tax year for education furnished during an academic period that starts within that tax year or within the first three months of the following year. Huh? This simply means that the academic period (let's use a semester for our example here) must begin within the tax year in which the expenses are paid OR the semester must begin within the first three months of the following year.
For example, if a semester begins in October 1998 and the expenses are paid in September 1998, the credit is available (assuming all of the other requirements are met). But how about a semester that begins in February 1999? When can you pay and take the HOPE credit for the expenses? The beauty is that you can pay them in 1998 OR 1999, and take the credit in the appropriate year. Obviously, for those of you with "academic periods" that begin early in 1999, you'll have a timing option to consider when claiming the credit.
The HOPE credit is available for expenses paid after 1997 for education furnished in academic periods starting on or after Jan. 1, 1998.
The HOPE credit is nonrefundable. That means that the HOPE credit can reduce regular income taxes to zero but can NOT result in the receipt of a refund. If the expenses on which the HOPE credit were based are later refunded (such as through a late payment of a scholarship), the credits may have to be recaptured and repaid back to Uncle Sammy.
As noted above, the HOPE credit is based on the payment of qualified tuition and related expenses. These are the expenses for tuition and academic fees at an eligible educational institution. Qualified tuition and related expenses do NOT include the cost of books, student activity fees, athletic fees, insurance expenses, room and board, transportation costs, and other personal living expenses. They also don't include the cost of any course or education involving sports, games, or hobbies unless the course or education is part of the student's degree program.
The amount of qualified tuition and related expenses taken into account in computing the HOPE credit must be reduced by tax-exempt scholarships and fellowships, certain military benefits, and any other tax-exempt payments of those expenses other than gifts or bequests.
But with the good news also comes the bad: The HOPE credit is phased out ratably for married taxpayers filing jointly with adjusted gross income (AGI), with certain modifications, between $80,000 and $100,000. That is, the credit is reduced if the modified AGI is above $80,000 and is completely lost if it's $100,000 or more. For taxpayers who aren't married filing jointly, the phase-out range is $40,000 to $50,000. After 2001, the phase-out amounts will be adjusted for inflation.
The HOPE credit is not available for taxpayers who are married filing separately. In addition, the HOPE credit is also not allowed to an individual who can be claimed as a dependent on another's return. In this situation, the HOPE credit is allowed only to the taxpayer claiming that individual as a dependent, and the credit is based on the total qualified tuition and related expenses paid both by the taxpayer and the student.
Note that the HOPE credit CAN be used to reduce the alternative minimum tax (AMT). Originally, when this legislation was passed the HOPE credit would reduce the regular tax, but not the AMT. But because of the recently passed Tax Relief and Trade Extension Act of 1998, the HOPE credit can be used to reduce both the regular tax and the AMT.
Finally, you should know that the eligibility for the HOPE credit is subject to a number of technical requirements not discussed above. You might want to check with your local higher education institution for the additional details and requirements. Virtually all colleges and universities have information available to more closely explain the HOPE credit. And, as always, if you have any specific technical questions on any of the HOPE credit issues, you can always leave 'em in the Tax Strategies message folder. Next week: A closer look at the Lifetime Learning credit.
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- 10/16/98
