You're paying a lot for your college education, so it's only fair that the government doesn't throw salt in the wound by forcing you to pay taxes on the money you put toward your schooling. It offers several tax breaks to those enrolled in a higher education program, including student loan interest deductions and tax-free scholarships if that money goes directly toward educational expenses.
Two of the most lucrative educational tax breaks are the American Opportunity Tax Credit and the Lifetime Learning Credit. But you can't claim them both in the same year. Here's what you need to know to decide which one is best for you.
American Opportunity Tax Credit
The American Opportunity Tax Credit can lower your tax bill by up to $2,500. You can get a credit for 100% of the first $2,000 you spent on tuition, books, and other classroom essentials, as well as 25% of the next $2,000. Money spent on transportation or room and board do not count toward this tax credit. Up to $1,000 of the tax credit is refundable, which means it can lower your tax bill below zero. So, even if you didn't owe any taxes during the year, you could file a return and claim the American Opportunity Tax Credit, and the government would mail you a $1,000 refund check.
You, or the student whose education you are paying for, must be enrolled at least half-time in a recognized undergraduate educational program, and you or the student may not have had four or more years of undergraduate schooling previously. The maximum number of times you can claim this credit is four for the first four years of undergraduate study. Students who have felony drug convictions on their record are not eligible for the American Opportunity Tax Credit.
There are also income limitations. Your modified adjusted gross income (MAGI) -- your adjusted gross income (AGI) with some tax deductions added back in -- cannot exceed $80,000 or $160,000 for married couples filing jointly. If your income exceeds these thresholds, the credit begins to phase out until single adults earning $90,000 or more and married couples filing jointly earning $180,000 or more are no longer eligible for this credit.
Lifetime Learning Credit
The Lifetime Learning Credit has more lenient requirements than the American Opportunity Tax Credit, but it's worth less -- just $2,000 at most. You can get a credit for 20% of your qualified educational expenses, up to $10,000 per year. Again, transportation and room and board do not count. The Lifetime Learning Credit is not refundable, so it can reduce your tax bill as low as zero, but no further. The good news is, there are no limits to how many years you can claim the Lifetime Learning Credit, unlike the American Opportunity Tax Credit. You can also claim it for graduate or professional education expenses, even if you're not actively pursuing a degree.
In order to claim the Lifetime Learning Credit, you must be enrolled at an eligible institution for at least one academic period during the year. This may be a semester, trimester, or quarter, depending on how your school structures its terms. The income requirements for this credit are lower, so higher-income individuals may not be able to claim it. Individuals with a MAGI over $58,000 and married couples filing jointly with a MAGI over $116,000 will see their Lifetime Learning Credit decrease until they are no longer eligible for it once their MAGI exceeds $68,000 or $136,000, respectively.
Which tax credit is best for you?
The American Opportunity Tax Credit is the best choice for most people if you or the student in question is enrolled in their first four years of undergraduate study. But if you've already claimed the American Opportunity Tax Credit for four years, or you or the student don't qualify due to felony drug convictions or enrollment in a graduate program, the Lifetime Learning Credit might be your only option.
High-income individuals may not be able to claim either of these tax credits. However, qualification requirements change from one year to the next, so just because you can't claim it this year doesn't mean you won't be able to claim it next year. Always check the tax credit requirements before you claim them to make sure you still qualify.
The American Opportunity Tax Credit and the Lifetime Learning Credit can both take a little of the financial sting out of getting a college education. Use the above information to decide which one is right for you.