American Opportunity and Lifetime Learning Credits

The two types of education credits provided by Code Section 25A are the American Opportunity credit and the Lifetime Learning credit.

The American Opportunity credit is equal to the lesser of either qualified tuition expenses paid or 100% of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified tuition expenses, for a maximum credit of $2,500, for each of the first four years of college.

The credit applies on a per-student basis. A taxpayer may claim the American Opportunity credit only with respect to qualified expenses for the first four years of higher education.

• An American Opportunity credit cannot be claimed if the student has any state or federal felony conviction for possession of a controlled substance.
• The dollar limit of the American Opportunity credit is indexed for inflation.

Tuition and related fees for graduate-level courses are not eligible for the American Opportunity credit, but may be eligible for the Lifetime Learning credit.

The Lifetime Learning credit is 20% of the first $10,000 of out-of-pocket qualified tuition and related expenses, for a top credit of $2,000. The credit applies on a per-taxpayer basis.

 Coordination of the American Opportunity Credit and the Lifetime Learning Credit

Generally a taxpayer must choose among the two credits and the above-the-line deduction for higher education expenses, depending on whichever option is more favorable.

 The education credits share a number of eligibility requirements

The MAGI of the taxpayer claiming the credit cannot exceed a threshold amount. MAGI is AGI figured without the foreign earned income exclusion. In 2011, a full credit can only be claimed by those with MAGI below $80,000 for singles ($160,000 on a joint return). The credit phases out for singles with MAGI between $80,000 and $90,000 (between $160,000 and $180,000 on a joint return). These limits are indexed for inflation.

Married persons must file jointly to claim a credit.

• The credit can be claimed only for qualified expenses of the taxpayer, the taxpayer's spouse, and/or an eligible dependent.
• For the American Opportunity credit, during the year the student must be enrolled at least half-time in one of the first four years of post-secondary education, in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period (e.g., semester, trimester, quarter). No similar requirement exists for the Lifetime Learning credit (i.e., even one course may entitle a taxpayer to a credit).
• The credit applies only to qualified expenses. These expenses include tuition and related expenses, such as fees required to be paid in order to be enrolled or attend the institution. Not treated as qualified expenses are amounts paid for a course involving sports, games, or hobbies unless they are part of a degree program; room; board; equipment; transportation; student activity fees; insurance; books; equipment; and other personal living expenses. Qualified expenses must be out-of-pocket expenses (i.e., amounts paid with savings, earnings, gifts, inheritances, and loans).
• Expenses paid with a Pell Grant or other tax-free scholarship, a distribution from a qualified tuition program, Coverdell ESA, or employer-provided educational assistance are not considered out-of-pocket expenses.
• The student can waive tax-free treatment for distributions from Coverdell ESAs or qualified tuition programs in order to allow the parent to claim the American Opportunity credit.

Money Saving Tip. If the parent's MAGI precludes him or her from claiming a credit, the child can claim it (even though the parent paid the expenses) as long as the parent foregoes the dependency exemption for the child. The child, of course, must have a tax liability in order to benefit from claiming the credit. And, the child cannot claim his or her own personal exemption (because he still qualifies as the parent's dependent).

The credit generally applies only to expenses paid in the academic period to which they relate. However, payment of expenses before the academic period beginning in January, February, or March can be taken into account when paid.

A taxpayer may be limited to the Lifetime Learning credit because of certain conditions.

For example, unlike the American Opportunity credit, students need not be enrolled at least half-time; even one course may give rise to a Lifetime Learning credit.

Also there is no limit on the number of years the credit can be taken. While the American Opportunity credit applies only for the first four years of higher education, a taxpayer may take the Lifetime Learning credit even for graduate-level courses.

The American Opportunity credit cannot be claimed with respect to a student who has a felony conviction for possessing or distributing a controlled substance but there is no similar ban for the Lifetime Learning credit.