Lifetime Learning Credit vs. American Opportunity Tax Credit


Fall brings many things to look forward to. Changing leaves, sweater weather, seasonal drinks, pumpkin everything and more. For most of us, thinking about college tuition doesn’t spark a high interest. I am one of four sisters who graduated from a 4-year university and college didn’t come cheap for our family.

The federal government has two key education tax credits that can provide your family with some financial assistance: the American Opportunity Tax Credit and the Lifetime Learning Credit. You are not allowed to take both credits and the requirements and limitations for each credit differ. Let’s take a closer look and determine which credit is best for you.

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 tax credit is worth 100% on the first $2,000 in qualifying expenses, and 25% of the next $2,000. This provides for a maximum annual credit of $2,500 if your qualifying educational expenses are $4,000 or more. In addition, the AOTC is what you call a refundable credit. Of the $2,500, you can receive up to $1,000 back even if you don’t owe taxes. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.

Claiming Education Credits

The credit is designed to help low to middle income taxpayers afford higher education expenses, either for themselves or a dependent. To claim the credit, the eligible student must be in the first four years of post-secondary education and must be enrolled in a degree or certificate program, taking classes on at least a half-time basis. They also must not have finished the first four years or higher education at the beginning of the tax year or claimed the AOTC or the former Hope credit for more than four tax years.

You are only allowed to claim the American Opportunity Tax Credit with tuition that you paid for with taxable savings. Sadly, double dipping isn’t smiled upon with the IRS. For example, when you take money from a 529 college savings plan to pay your tuition, that withdrawal is tax-free so you can’t also claim the AOTC for those funds.

Income Limitations

The American Opportunity Tax Credit begins a phase out for modified adjusted gross income (MAGI) above $80,000 for single taxpayers and above $160,000 for married taxpayers filing jointly. Partial credits are available for those with MAGI above the limit, but still under specified dollar amounts.

Qualifying Expenses

The expenses that count toward the credit are limited. You are able to deduct tuition payments, required fees, and course materials, but subsidiary items like room and board or transportation costs don't qualify. The expenses must also be paid to an eligible institution, which generally refers to any accredited public, nonprofit, or for-profit college, university, or vocational school that is eligible for a U.S. Department of Education student-aid program.

Tuition owed must be paid for a period beginning during the calendar year or during the first three months of the following year. For instance, if you paid tuition in December 2016 for the Spring 2017 semester, that is a qualifying event and you can use that to figure your 2016 credit.

What is the Lifetime Learning Credit?

If you don’t qualify for the American Opportunity Tax Credit don’t lose hope! The Lifetime Learning Credit (LLC) is the next best option for those who qualify. This tax credit is less restrictive than the AOTC which makes it available to more taxpayers and is much more flexible. The LLC is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses which includes courses to acquire or improve job skills.

The credit accounts for 20 percent of the first $10,000 of qualified education expenses or a maximum of $2,000 per return. Unfortunately, the LLC is non-refundable so you won’t receive any of the credit back as a refund.

Claiming Education Credits

If your child is going to college and you claim him or her as a dependent, then you can claim the education credits on your tax return. If your child is no longer a dependent, then he or she should claim any education credits on their own tax return.

Unlike the AOTC, the student no longer has to be in the first four years of post-secondary education, does not need to be pursuing a degree or certificate and there are no half-time enrollment requirements. The credit is available throughout your lifetime and there is no limit on the number of years you can claim the credit. Keep in mind, the same rule applies to the LLC as the AOTC. You are only allowed to claim the tax credit with tuition costs you paid for with taxable savings.

Income Limitations

When it comes to income limits, the Lifetime Learning Credit isn’t as generous as the American Opportunity Tax Credit, but it’s still considerable. It begins to phase out above MAGI of $55,000 for single filers and $111,000 for married filing jointly, and disappears completely above thresholds of $65,000 and $131,000, respectively.

Qualifying Expenses

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. Tuition and required fees qualify for the LLC credit, but expenses such as books, supplies, and equipment only count if they are paid directly to the institution as a condition of enrollment.

For further illustration and information, please see the following comparison chart:

Determining Which Credit to Claim

In general, it is best to claim the American Opportunity Tax Credit if you qualify. This option not only provides a larger amount of credit, but you don’t have to spend as much in order to receive the credit. Furthermore, there are restrictions on years of eligibility so you might as well take the credit when it’s available.

On the other side, and mentioned above, the Lifetime Learning Credit is available to many more individuals. If you have already partaken in four years of post-secondary education and are pursuing a graduate degree – then claim the LLC if you qualify.

It is important to note that there will be situations where you or a family member won’t be able to claim either credit, but it “pays” to take the American Opportunity Tax Credit or the Lifetime Learning Credit, if you meet the eligibility requirements for one or both of the credits.

Planning Tip

If you qualify for either of the educational credits, it may be advantageous to spend your first $4,000 (for the AOTC) or $10,000 (for the LLC) of college expenses out-of-pocket with taxable income or savings (taxable investment accounts, CDs, money market, etc.) Once you’ve done that, you can draw the remainder of the funds you need from a 529 plan or other tax-advantaged education account or investment. As I mentioned earlier in this article, you cannot claim the AOTC or LLC tax credits for education costs that were paid from funds distributed as tax-free withdrawals from 529 plans or education IRAs.

For example, rather than spending $20,000 out-of-pocket (outside of 529s, educational IRAs, etc.) during the final year of your child’s education, consider spreading that out over the 4 years to take advantage of the tax credit each year.

As you can see, there are multiple planning factors to evaluate. Seeking guidance from a professional is always a good idea and ensures that your specific situation is taken into consideration. At HFG Trust, our advisors are always happy to help.



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