The Hope credit and lifetime learning credit are two tax credits available to help pay for college for you, your spouse, or your dependent. A tax credit provides a dollar-for-dollar reduction in the amount of federal income taxes that you owe. Beginning in 2009 new credit provisions called the American Opportunity Tax Credit modified the Hope credit. Those provisions were set to expire in 2017 but were made permanent by Congress as part of the Protecting Americans from Tax Hikes legislation in December 2015.
For example, if you owe $2,000 in income taxes and have a $1,000 tax credit, you cut your tax bill in half. In general, you cannot receive a refund for the portion of a tax credit that exceeds the amount of federal income taxes that you paid.
The Hope/American Opportunity Tax Credit can be used for expenses incurred in the first four years of college, up to $2,500 per year in 2021. The amount of the Hope credit will continue to be indexed for inflation.
The lifetime learning credit applies to tuition costs for undergraduates, graduates, and those improving job skills through a training program. In 2021, this credit is 20% of up to $10,000 in qualified expenses, or a maximum of $2,000. Neither the amount of qualified expenses nor the credit amount is indexed for inflation.
You can receive tax-free distributions from education savings accounts or QSTPs without affecting your use of the Hope or lifetime learning credit. The only stipulation is that you don't claim the credit for expenses that you pay with these tax-advantaged accounts. Distributions from an education savings account or QSTP are excluded from income when calculating the credit.
You must complete IRS Form 8863: "Education Credits" if you use either credit.
To help you calculate your credit, the IRS requires the school that you attend to mail a Form 1098-T: "Tuition Statement" by Feb. 1.
The lifetime learning credit phases out at higher incomes. For taxpayers filing a single return in 2021, the tax credits begin to phase out when modified adjusted gross income (MAGI) reaches $59,000. For couples filing a joint return, the credits begin to phase out when income reaches $119,000. These credits phase out completely when income reaches $69,000 for single persons and $139,000 for married persons filing a joint return. Similarly, the American Opportunity Tax Credit phases out between $160,000 and $180,000 for joint filers and $80,000 and $90,000 for all others.
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.
Next, we'll take a look at using savings bonds to save for future college expenses.