Education-Related Incentives

The American Recovery and Reinvestment Act (ARRA), enacted last year, included several key education-related changes designed to help make college more affordable for taxpayers.

Tax Credit for College Expenses Extended to Four Years

The Act modifies the existing Hope Credit for tax years 2009 and 2010, renaming it the American Opportunity Credit. Changes to eligible expenses, the amount of the credit and the income phase-out ranges combine to give a greater benefit to a greater number of taxpayers. Some of the key features of the credit include:

• Expenses which qualify for the credit include tuition, related fees, books and other required course materials. This marks a change from the previous rules in which amounts paid for books did not qualify, and helps to alleviate some of the “sticker shock” often associated with a student’s expenses at the start of each semester.
• The credit amount per eligible student is equal to 100% of the first $2,000 of qualified expenses plus 25% of the next $2,000 of qualified expenses, allowing for a maximum credit amount per student of $2,500. Thus, if a taxpayer pays at least $4,000 in qualified expenses for an eligible student, he or she may be able to claim the full amount of the credit. Under the credit’s previous incarnation, the maximum amount allowable was limited to $1,800.
• Some taxpayers may not be able to utilize the entire credit; for single taxpayers with modified adjusted gross income (AGI) greater than $80,000 and married taxpayers filing jointly with modified AGI greater than $160,000, the credit begins to be phased out. The credit is completely phased out when the taxpayer’s modified AGI reaches $90,000 and $180,000 respectively. Again, these ranges are an increase from the Hope Credit phase-out amounts of $50,000 to $60,000 for single taxpayers and $100,000 to $120,000 for married taxpayers filing jointly.

In addition, some administrative features of the credit have been changed to make it more appealing. The credit is now refundable up to 40% (for a maximum refundable amount of $1,000). Furthermore, whereas taxpayers could only claim the Hope Credit for the first two years of a student’s post-secondary education, the American Opportunity Credit is now available for up to four years of a student’s education. The Lifetime Learning Credit is still available for students who continue their education beyond four years. This credit will be applicable to both graduate students and undergraduate students whose regular course work carries beyond the initial four year span covered by the American Opportunity Credit.

Additional Expenses Covered by – 529 Plans

In recent years, qualified tuition plans authorized under Internal Revenue Code section 529 (529 plans) have become increasingly popular as a method of saving for college. Generally, although contributions to a 529 plan are not deductible, distributions from a 529 plan that are used to pay qualified higher education expenses for a designated beneficiary are tax-free to the recipient. Previously, “qualified expenses” included tuition, required fees, books, supplies, equipment and special needs services; as well as room and board for someone who is at least a half-time student. Under ARRA, the qualified expenses for 529 plans have been expanded to include computer technology and equipment, internet access and related services. This does not include software designed for sports, games or hobbies unless it is predominantly educational in nature.