Tax Credits for Education Expenses

How do I claim the $2,500 tax credit for college expenses when I file my 2010 federal tax return? Is the credit still in effect for college costs incurred in 2011?

I’ve been inundated with questions from parents who are paying college tuition bills and are wondering if they’re eligible to claim the American Opportunity Credit. To qualify for the full credit, which can cut your tax bill by $2,500, you must spend at least $4,000 in tuition and qualified expenses (including fees, books and related course materials) during the calendar year. You can get a partial credit if you pay less than $4,000 for college costs –- the actual calculation for the credit is 100% of the first $2,000 in tuition and eligible expenses, plus 25% of the next $2,000 of eligible expenses. The tax credit only applies to expenses incurred during the first four years of college; it’s not available for graduate students.

There are income limits to qualify for the American Opportunity tax credit, too: The full credit is available to eligible taxpayers who make less than $80,000, and a partial credit is available to individuals with income between $80,000 and $90,000. For married couples filing jointly, the income limit for the full credit is $160,000, and a partial credit is available for couples with income up to $180,000.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The rules can get complicated for divorced parents –- see Divorced Parents and Education Tax Breaks for more information about who can claim the credit.

To qualify for the credit, you cannot be claimed as a dependent by someone else. So parents can claim the credit for their dependent students, or students who file their own tax returns and who are not dependents of any other taxpayer can claim the American Opportunity credit for eligible college costs.

Also,40% of the credit is refundable, so even those who owe no tax can get up to $1,000 of the credit for each eligible student as cash back.

You can’t claim the credit in the same year that you claim a deduction for college costs. In general, if you are eligible for both, claim the more valuable credit, which reduces your tax bill dollar for dollar, rather than the deduction, which merely reduces the amount of income that is taxed.

Graduate students aren’t eligible for the American Opportunity Credit, but they may qualify for the Lifetime Learning Credit, which could reduce their tax bill by up to $2,000 per return -- the credit is calculated as 20% of up to $10,000 of qualified expenses. However, the income limits for the Lifetime Learning Credit are lower ($120,000 if married; $60,000 if single) See IRS Publication 970 Tax Breaks for Education for more information about both types of credits.

To claim either credit, you’ll need to file Form 8863 with your 1040. See the instructions for Form 8863 for more details.

Although the American Opportunity Credit had been scheduled to expire at the end of 2010, the tax law signed in December extended the credit through 2012.

For more information about the American Opportunity Credit, see Make the Most of Tax Breaks for College Expenses.