Death & Taxes

The Hope Scholarship Credit

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By Roy Lewis
May 3, 2002

Two major education provisions included in the 1997 Taxpayer Relief Act were 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. This article covers the Hope credit. (We'll cover the Lifetime Learning credit in a subsequent article.)

The Hope credit (not another government acronym, simply short for the Hope Scholarship 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 can 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:

  1. 100% of the first $1,000 of qualified tuition and related expenses paid, plus
  2. 50% of the next $1,000 of qualified tuition and related expenses paid.

So if Max's freshman tuition at college costs $15,000, he (or whoever claims him as a dependent) can claim the full $1,500 credit: 100% of the first $1,000 ($1,000) and 50% of the next $1,000 ($500). But, on the other hand, if Joan is attending college and her expenses amount to $1,600 for the year, she can claim just $1,300: 100% of the first $1,000 ($1,000) and 50% of the next $1,000 (50% of $600 is $300).

Highlights of the Hope credit
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). 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. Additionally, if part of the qualified education expenses is paid with tax-exempt distributions from a Coverdell ESA or 529 plan, the credit may be limited or reduced. So you'll want to make sure that you understand the rules. And we'll cover those rules in greater detail in the upcoming weeks. But for now...onward!

The Hope and Lifetime Learning credits cannot be claimed in the same tax year for the same expenses, but each may be claimed for different expenses.

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 2002 and the expenses are paid in September 2002, the credit is available (assuming all of the other requirements are met). But what about a semester that begins in February 2003? When can you pay and take the Hope credit for the expenses? The beauty is that you can pay them in 2002 or 2003, and take the credit in the appropriate year. Obviously, for those of you with "academic periods" that begin early in a calendar year, 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 cannot cause you to receive a tax refund. If the expenses on which the Hope credit was based is later refunded (such as through a late payment of a scholarship), the credits will have to be recaptured and repaid back to Uncle Sam.

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.

High-income taxpayers: Beware!
With the good news also comes the bad. The Hope credit is phased out ratably for married taxpayers filing jointly with a modified adjusted gross income (AGI) 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. Beginning in 2002, these phase-out amounts will be adjusted for inflation.

Additionally, the Hope credit is not available for taxpayers who are married filing separately, or for an individual who is claimed as a dependent on another's return. In the latter 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.

Finally, 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 carefully explain the Hope credit. Or, you can drift over to the IRS website and download IRS Publication 970, which deals with credits and deductions for higher education.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though. 

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