The New, Improved College Tax Credit

Beginning for 2009, most parents of college students can get a $2,500 break.

There’s a new $2,500 college tax credit for 2009, 2010 and possibly beyond. Even if your family hasn’t qualified for earlier college tax credits, this one might put thousands of extra dollars in your pocket. 

Technically, the new credit is an expansion of the old Hope college credit. But many more families (including both low-income and upper middle-income) qualify. Married couples filing jointly who have modified adjusted gross income of up to $160,000 ($80,000 for single parents) can claim the full credit for 2009 and 2010. Above that income level, the credit gradually phases out, with those earning up to $180,000 ($90,000 for singles) eligible to claim a partial credit. By contrast, the old Hope credit was available in full for 2008 only to couples with incomes below $96,000 ($48,000 for singles). The expanded credit can even by claimed by taxpayers paying the alternative minimum tax (AMT).

The new credit is also partially refundable. What that means is a family which doesn’t earn enough to pay income taxes will get $1,000 back. A family which would otherwise owe, for example, $2,000 in income tax, should qualify for the full $2,500–it would have its $2,000 tax bill wiped out and get $500 back as part of the refundable credit.

The American Opportunity credit is only for undergraduates going more than half time and doesn’t replace the existing $2,000 Lifetime Learning tax credit. (That one is still useful for graduate and part-time students.)  But it can be claimed for all four years of undergraduate study, whereas the old Hope credit was only good for two years.

The amount of the new credit equals 100% of the first $2,000 of qualified tuition and expenses paid and 25% of the next $2,000 of expenses. So a student must have incurred $4,000 in eligible expenses for a family to receive the $2,500.

What are eligible expenses? That’s the amount of qualifying tuition and related expenses, including student activity fees and required books, paid to an eligible educational institution on behalf of a student (the taxpayer, spouse or dependent) who is studying at least half-time.

Virtually all accredited public, nonprofit and proprietary (meaning privately owned and profit-making) postsecondary institutions qualify as eligible schools. That’s simple. Figuring what your family “paid” is trickier.

That’s because you can’t claim the American Opportunity or Lifetime Learning credits for any expenses that were covered by the tax-free portion of a distribution from a 529 state college savings plan, a 529 state prepaid plan or a Coverdell Education Savings Account (ESA).

The credit also can’t be claimed against expenses paid from the following sources:

–Tax-free scholarships and fellowships;
–Pell grants from the federal government;
–Employer-provider educational assistance (tuition reimbursement);
–Veterans’ educational assistance;
–Other tax-free payments received as educational assistance.

Here’s the key: You can claim the credit in the same year as any of the above, just not for the same expenses. For example, if a child has $4,000 in qualified educational expenses attending a state university and gets $4,000 in Pell grant money, he has no remaining qualified educational expenses left to claim a tax credit against. If he’s got $8,000 in expenses and a $4,000 Pell, he can qualify for the full $2,500 American Opportunity credit too. If his family has too little income to pay any income tax, it can still get a $1,000 refundable credit.

By Troy Onink who is a college funding consultant who provides advice on paying for college at www.stratagee.com.