Making College More Affordable: The Education Provisions of the Taxpayer Relief Act of 1997 Can Help

Thanks to the Taxpayer Relief Act of 1997, families with college-bound students (parents included), can take advantage--starting this year--of a variety of new tax benefits. These include the Hope scholarship and lifetime learning credit, the education IRA, penalty-free individual retirement account distributions, a deduction for interest on education loans and qualified state tuition programs. As is often the case with new tax legislation, only taxpayers with adjusted gross incomes (AGIs) below certain limits can take full advantage of the benefits. Since such tax payers normally are not confronted with complex tax planning decisions, CPAs will need to make sure those clients thoroughly understand the new provisions. Because not all of the changes are available or beneficial to every taxpayer and some can be used only at the exclusion of others, the explanation of each of the benefits below is followed by an analysis of the opportunities and limitations. In addition, the provisions' compatibility with the others also is discussed. HOPE SCHOLARSHIP AND LIFETIME LEARNING CREDITS The Hope scholarship is a tax credit equal to 100% of a student's first $1,000 of qualified education expenses plus 50% of the next $1,000. The maximum credit of $1,500 per student is available in each of the first two years of a postsecondary degree program. To qualify, a student must attend an eligible higher education institution on at least a half-time basis for one academic period during the year. The lifetime learning credit is 20% of qualified education expenses paid by a taxpayer (up to $5,000 of qualified expenses before 2003 and up to $10,000 thereafter). A maximum credit of $1,000 per year ($2,000 annually after 2002) is permitted for an unlimited number of years. Unlike the Hope credit, qualified tuition expenses for the life time learning credit include the cost of instruction taken to acquire or improve existing job skills. This means the cost of continuing professional education at colleges and universities may now be a creditable expense. Taxpayers are not allowed a deduction and a credit for the same expense. Both credits are granted for qualified education expenses of the taxpayer, the taxpayer's spouse and his or her dependents. The payor of the qualified expenses is entitled to the credit, and any education expenses a dependent pays are treated as paid by the taxpayer claiming the dependent. The credits are nonrefundable--neither credit will be refunded to the taxpayer if they exceed his or her tax liability. Opportunities and limitations. A taxpayer cannot claim both credits simultaneously for one student in the same year. Under current rules, the Hope credit produces a larger tax benefit per student for any given expense. The Hope credit dollar limitations also apply on a per-student basis. So, for example, two eligible student's in a family can generate a maximum $3,000 Hope credit. On the other hand, the lifetime learning credit is limited to $1,000 per tax return, regardless of the number of eligible students. Although a student cannot use both credits in the same year, a taxpayer can take both Hope and lifetime learning credits in the same tax year if more than one student in the household incurs qualified expenses. A Hope credit is available for expenses paid and academic terms beginning after December 31, 1997. Expenses prepaid in 1997 for an academic term beginning in 1998 are not eligible. Timing of payments also is important in the second and final year of Hope credit eligibility. If a taxpayer's payments during the second year exceed the annual limits, prepayment of the following year's tuition effectively wastes credits. Postponing payment until the following year qualifies the payments for the lifetime learning credit. The lifetime learning credit is available for expenses paid and education beginning after June 30, 1998. Example. …