American opportunity credit and lifetime learning credit are the two education credits available on 2016 federal income tax return that help you to offset the costs of higher education by reducing the amount of your income tax. According to IRS Publication 970, you are eligible to claim these two credits if you are an eligible student or you paid qualified education expenses for an eligible student who is your dependent for whom you claim an exemption on your tax return.
If both you and your dependent are eligible to claim the credits, only one of you can claim the credits on your return. The example below helps you to decide who should claim American opportunity credit or lifetime learning credit so that you can get the most tax benefit/credit.
Example: John is a 20-year-old full-time college student and single in 2016. His only income is $10,000 wage from his summer job in 2016. His expenses in 2016 include $40,000 tuition, $10,000 rent and $6,000 food plus $2,000 clothing and $2,000 travel expense. John’s parents file joint return in 2016 and have modified adjusted gross income (MAGI) of $200,000.
Step 1: Go through the 5 tests on Table 4. Tests To Be a Qualifying Child to determine if John is a dependent.
Since John meets all five tests he is a dependent of his parents.
Note 1: If John does not meet the 5 tests, he is not a dependent. He is the only one who can claim the education credits. There is no need to go through the rest of steps below.
Note 2: If John is a dependent but earned less than $6,300 in 2016, he is not required to file tax return and can’t get any education credit due to limited income he earned. His parents should claim the education credits.
Step 2: Use the tables below to decide who should take the credits based on the modified adjusted gross income of John’s parents.
Since the MAGI of John’s parents is $200,000, the amount of education credit they can claim is phased out to 0 (reduced to 0). It may be better to let John claim the education credit. If John is going to claim the credit, his parents will not be able to claim him as dependent and take exemption on their return. John also can’t claim exemption on his return. We should go through Step 3 to determine whether claiming exemption by John’s parents has more tax benefit than claiming education credit by John.
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Step 1: Go through the 5 tests on Table 4. Tests To Be a Qualifying Child to determine if John is a dependent.
Since John meets all five tests he is a dependent of his parents.
Note 1: If John does not meet the 5 tests, he is not a dependent. He is the only one who can claim the education credits. There is no need to go through the rest of steps below.
Note 2: If John is a dependent but earned less than $6,300 in 2016, he is not required to file tax return and can’t get any education credit due to limited income he earned. His parents should claim the education credits.
Step 2: Use the tables below to decide who should take the credits based on the modified adjusted gross income of John’s parents.
Since the MAGI of John’s parents is $200,000, the amount of education credit they can claim is phased out to 0 (reduced to 0). It may be better to let John claim the education credit. If John is going to claim the credit, his parents will not be able to claim him as dependent and take exemption on their return. John also can’t claim exemption on his return. We should go through Step 3 to determine whether claiming exemption by John’s parents has more tax benefit than claiming education credit by John.
Step 3: Prepare John’s return and his parents’ return in two ways:
1. On his parents’ return, claim a dependent exemption for him and also claim education credits. On his return, do NOT claim exemption and education credits.
2. On his parents’ return, do NOT claim a dependent exemption for him (even his parent is entitled to the exemption). On his return, do NOT claim exemption but DO claim education credits.
2. On his parents’ return, do NOT claim a dependent exemption for him (even his parent is entitled to the exemption). On his return, do NOT claim exemption but DO claim education credits.
3. Compare the results and choose the way with less total tax liability.
Assume that John’s parents take standard deduction on their return in this example. The total tax liability is about $700 less if John’s parents claim John as their dependent and take exemption. However, if John earned $20,000, it is better for John to claim the education credit.
Note: It should only take you a few minutes to complete Step 3 if you use tax preparation software to prepare your return.
For high income earners, if your modified AGI is over the limit, you will not be able to claim any education credit. And if you have to pay AMT tax, you can’t even claim personal exemption for your children. It is better for you to encourage your children find a part time or summer job, so that they can earn enough income to claim education credit or personal exemption by themselves. If you are self-employed, you can hire your children and pay enough wages to them so they can claim both education credit and personal exemption.
How to Use Form 1098-T to Figure American Opportunity Credit or Lifetime Learning Credit
Assume that John’s parents take standard deduction on their return in this example. The total tax liability is about $700 less if John’s parents claim John as their dependent and take exemption. However, if John earned $20,000, it is better for John to claim the education credit.
Note: It should only take you a few minutes to complete Step 3 if you use tax preparation software to prepare your return.
For high income earners, if your modified AGI is over the limit, you will not be able to claim any education credit. And if you have to pay AMT tax, you can’t even claim personal exemption for your children. It is better for you to encourage your children find a part time or summer job, so that they can earn enough income to claim education credit or personal exemption by themselves. If you are self-employed, you can hire your children and pay enough wages to them so they can claim both education credit and personal exemption.
Please share this post with your friends.
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