Families with kids in college need all the financial help they can get, and the federal government has two key education tax credits that can provide much-needed assistance: the Lifetime Learning Credit and the American Opportunity Tax Credit. However, you're not allowed to take both credits, and the requirements and limitations on taking each credit differ. Which you should claim depends on which credits you qualify for, as well as some other factors that you'll learn about below.
What is the American Opportunity Tax Credit?
The American Opportunity Tax Credit provides credits for up to four years of post-high-school undergraduate college education. This credit is the more generous of the two education tax credits, providing you with a 100% credit amount on up to $2,000 in annual expenses, along with an additional 25% credit for the next $2,000 in expenses. What that means in practical terms is that you can get a maximum credit of $2,500 if your qualifying educational expenses are $4,000 or more.
To qualify for the credit, you have to be enrolled at least half-time in college, and you must be in a degree program or be eligible to receive a certificate or similar educational credential at the completion of your studies. If you've already finished four years of college or other education after high school, then you no longer qualify for the American Opportunity Tax Credit.
The expenses that count toward the credit are limited. You can deduct tuition payments, required fees, and course materials. Ancillary items like room and board or transportation costs don't qualify.
In addition, there are income restrictions that limit the availability of the credit. If modified adjusted gross income (MAGI) is above $90,000 for single filers or $180,000 for joint filers, then you can't claim the American Opportunity Tax Credit. Only partial credits are available for those with MAGI above $80,000 and $160,000, respectively.
Another benefit of the American Opportunity Tax Credit is that you can receive up to 40% of the credit amount even if you don't have any tax liability at all. That's because the credit is partially refundable, meaning you can receive a refund for a portion of the credit irrespective of whether you would otherwise owe any taxes.
What is the Lifetime Learning Credit?
The Lifetime Learning Credit is less restrictive than the American Opportunity Tax Credit in many ways. As its name applies, the Lifetime Learning Credit is available throughout your lifetime, whether you're an undergrad, graduate student, or older nontraditional student taking classes for job training or other purposes. You don't have to be part of a degree program or be a half-time student to qualify for the Lifetime Learning Credit.
The Lifetime Learning Credit isn't as generous as the American Opportunity Tax Credit, but it's still substantial. The credit is 20% of the first $10,000 you spend on qualified educational expenses for a given year. That produces a maximum credit of $2,000. The same expenses of tuition and required fees and materials qualify, but the credit is nonrefundable, so you can't use it if you don't otherwise have tax liability.
There are also income limits on the Lifetime Learning Credit, but they're a bit lower than those of the other education credit. MAGI of $65,000 for singles or $131,000 for joint filers is the upper limit, and only partial credits are available for incomes above $55,000 or $111,000, respectively.
Which credit should you take?
In general, there's a simple rule for most people: Take the American Opportunity Tax Credit if you qualify. It provides a larger amount of credit, and you don't have to spend as much in order to get that credit. Moreover, you can't save years of eligibility for the American Opportunity Tax Credit for the future, so there's no reason not to take the credit when it's available.
By contrast, the Lifetime Learning Credit is available to a much wider group of people. If you're not an undergraduate student, then claim the Lifetime Learning Credit if you can. The fact that this credit has a lower income threshold than the American Opportunity Tax Credit means that there are some situations in which you won't be able to take either credit.
Tax credits are great ways to get a bit back some of the money you spend on your educational expenses. It pays to take the American Opportunity Tax Credit or the Lifetime Learning Credit -- in that order -- if you meet the eligibility requirements for one or both of the credits.