One of the U.S. income tax benefits available to help offset the costs of higher education is the Hope credit. Since this is a credit rather than a deduction, it directly reduces your income tax liability. If you pay qualified education expenses for an eligible student, the Hope credit can reduce your taxes by up to $1,500 per eligible student. The Hope credit is a nonrefundable credit, which means that it can reduce the amount of taxes you have to pay, but it will not entitle you to a refund if it reduces your tax liability below zero.
The Hope credit is just one of the tax benefits available for education. Another credit is the lifetime learning credit. And there is a tuition and fees deduction, that reduces your adjusted gross income subject to tax. You generally cannot use the same education expenses to qualify for more than one tax benefit for the same student. But if you have more than one student eligible for the credits or deduction, you may be able to take advantage of different benefits for different students. So you may want to calculate your taxes using the different benefits, to see which results in the lowest overall tax liability.
Who Can Claim the Hope Credit
There are three tests that must be met in order to claim the Hope credit:
1. You must have paid qualified higher education expenses.
2. You must have paid the expenses for an eligible student.
3. The eligible student must be you, your spouse, or a dependent for whom you can claim an exemption on your tax return.
“Qualified education expenses” and “eligible student” are defined below.
There are certain taxpayers who are not entitled to claim the Hope credit. You cannot claim the credit if you are married filing separately, or if you can be claimed as a dependent on someone else’s income tax return. If you (or your spouse if you are married) was a nonresident alien during any part of the year, and you did not elect to be treated as a U.S. resident for income tax purposes, you will not be eligible to claim the Hope credit.
Modified Adjusted Gross Income Limit
There is also a maximum amount of modified adjusted gross income allowable for taking the credit. There is a phase-out of the credit for modified adjusted gross income over a certain amount, up to the ceiling, or maximum amount, at which point the Hope credit would be zero. These limits on modified adjusted gross income are subject to change, and can be found in the instructions and publications the Internal Revenue Service (IRS) issues each year. For more information, you can refer to IRS Publication 590, Tax Benefits for Education. This publication is available on the IRS website at www.irs.gov.
What Education Expenses Qualify
The expenses that qualify for the Hope credit are tuition and certain related expenses required for enrollment at an eligible educational institution. Eligible educational institutions include colleges, universities, vocational schools, and other postsecondary educational institutions, whether public, private or non-profit.
Related education expenses include student-activity fees and expenses for course-related books, supplies, and equipment, provided the fees and expenses must be paid to the educational institution as a condition of attendance or enrollment. If books, supplies and equipment are required for a mandatory course, but do not necessarily have to be purchased directly from the educational institution, they are not qualified education expenses for purposes of the Hope credit. There must be a requirement to purchase them from the institution itself.
Student activity fees that are required of all students, and that are used to fund on-campus organizations and activities, are qualified education expenses, even though they are not directly related to specific courses. The fact that they are required for enrollment or attendance makes them qualified education expenses.
Tax-Free Educational Assistance
If you receive any tax-free educational assistance, you will have to reduce your qualified expenses by the assistance you receive when you calculate the amount of educational expenses eligible for the Hope credit. Tax-free educational assistance includes the tax-free parts of scholarships or fellowships, Pell grants, educational assistance provided by an employer, veteran’s educational assistance, and any other nontaxable amounts you receive as educational assistance, other than gifts or inheritance.
Also, you cannot claim the Hope credit on education expenses that were used to determine the tax-free portion of a distribution from a Coverdell Education Savings Plan (ESA) or from a Qualified Tuition Program (QTP).
Student Funds That Do Not Reduce Qualified Expenses
You do not have to reduce your qualified education expenses by amounts that are paid with funds the student receives from wages earned from working. You can pay the education expenses with the proceeds from loans you or the student take out to finance the education expenses. And you do not have to reduce the amount of qualified expenses paid with gifts or inheritance, or a withdrawal from the student’s savings.
Effects of Scholarships and Fellowships
Qualified education expenses do not have to be reduced by any part of scholarships or fellowships that the student has to report as income on his or her income tax return. This would be the case if money from a scholarship is restricted to paying for costs of attendance other than qualified education expenses. This would include room and board, for example. Or, the scholarship or fellowship would also have to be reported as income if there are no restrictions on how the money is to be used, and it is used to pay education expenses that are not qualified.
1. A student pays tuition of $1,500 and room and board of $2,000 for the year. The student’s financial aid award package consists of a scholarship for $800 and a loan of $2,700. There are no restrictions on how the scholarship is to be used. The student uses the scholarship to pay part of the tuition, which is a qualified education expense, so the scholarship is tax-free. The student would have qualified education expenses of $700 eligible for the Hope credit (tuition of $1,500 minus the scholarship of $800). The cost of room and board is not a qualified education expense.
2. Assume the same facts as in 1, except that the student uses the scholarship to pay room and board. The scholarship would have to be reported as income on the student’s tax return since it was used to pay other than qualified education expenses. But the entire amount of the tuition would be eligible for the Hope credit, as a qualified education expense paid with the student’s funds (the loan).
Expenses That Are Not Considered Qualified Education Expenses
For purposes of the Hope credit, qualified education expenses do not include room and board, health insurance (even if required) or medical expenses, travel and transportation, and other similar personal living expenses. Expenses related to sports, games, hobbies, and noncredit courses also do not qualify. If the educational institution combines all expenses into one amount, it should send you a Form 1098-T, Tuition Statement, that will show the amount of qualified education expenses.
In order to claim the Hope credit, the student must be pursuing an undergraduate degree or other recognized educational credential, and must be enrolled at least half time for at least one academic period beginning during the year. There is also a rule that the student must not have any felony drug convictions on record.
Being enrolled at least half time means taking at least half the normal full-time workload for the student’s course of study. This normal workload is determined by each educational institution. And, the student does not necessarily have to be enrolled at least half time all year. The requirement is that the student must be enrolled at least half time for at least one academic period that begins during the year. This means that the student could be enrolled at least half time during one semester each year and still qualify for the Hope credit.
The academic period can be a period that begins during the first three months of the following year. For example, if you pay qualified education expenses this year for a semester that begins in January of next year, your expenses would qualify for the Hope credit this year – the year you paid them in advance.
The Hope credit is available for the first two years of postsecondary education per student. This rule is expressed in two ways: if the student has already completed the first two years of postsecondary education, he or she is not eligible for the Hope credit. And, the credit can only be taken for two years. Once those two years have been completed, the student is no longer eligible for the Hope credit.
But a student can take a one-year course leading to a certificate or degree, and then enroll in the same or another educational institution leading to a certificate or degree and claim the Hope credit for both years. The fact that a certificate or degree is obtained after one year will not disqualify the student from taking the Hope credit for a second year while pursuing another course of study. After the Hope credit has been claimed for two years, or the first two years of postsecondary education have been completed, the student will no longer qualify for the Hope credit but may still be eligible for the lifetime learning credit or the tuition and fees deduction.
Either you or your dependent can claim the Hope credit for qualified education expenses. In order for you to claim a credit for your dependent’s expenses, you must also claim a dependent exemption on your tax return for the student. If you do not claim the exemption, the dependent can claim the Hope credit on his or her own tax return. This is true even if you were entitled to claim the dependent. If neither you nor anyone else claims the dependent exemption, only the dependent can claim the Hope credit, providing he or she qualifies.
If you claim a credit for a dependent’s expenses, you can include the expenses you paid yourself and the expenses paid by the dependent, as if you had paid them. If someone else, such as a relative or ex-spouse, makes payments directly to the educational institution on the student’s behalf, these payments are considered to have been paid to the student, and then by the student to the educational institution. If you can claim the student as your dependent, you can include these expenses when figuring the Hope credit, since they are considered to have been paid by the student.
Figuring the Credit
The amount of the Hope credit is calculated as 100% of the first $1,000 of qualified education expenses paid for an eligible student, and 50% of the next $1,000, up to a maximum credit of $1,500 per year, per student.
As mentioned above, the amount of the Hope credit you can claim is phased out for modified adjusted gross incomes over a certain amount, up to a maximum ceiling. To determine whether you are subject to the phase-out, you would take your adjusted gross income as reported on your tax return for the year in which you are claiming the Hope credit, and adjust it by adding back any deduction you claimed for the foreign earned income or foreign housing exclusions, any exclusion of income for bona fide residents of American Samoa, and the exclusion of income from Puerto Rico. If you do not have any of these exclusions, your modified adjusted gross income would be the same as your adjusted gross income.
How To Claim the Hope Credit
You claim the Hope credit by completing Parts I and III of Form 8863, Education Credits (Hope and Lifetime Learning Credits), and filing this form with your tax return – either Form 1040 or 1040A. If you claim the Hope credit you cannot use Form 1040EZ.
If your modified adjusted gross income is in the phase-out range, you will determine the portion of your expenses that qualify for the Hope credit on lines 8 to 14 of Form 8863. You would first figure your tentative credit (100% of the first $1,000 of expenses, and 50% of the next $1,000) in Part I. Then in Part III, your tentative credit is ratably reduced based on the amount by which your modified adjusted gross income exceeds the base amount at which the phase-out range begins.
For more information, see IRS Publication 970, Tax Benefits for Education. This publication, as well as Form 8863 are available for downloading from the IRS website at www.irs.gov.