For tax years beginning in 2009 and 2010, the Stimulus Act includes taxpayer-friendly modifications to the Hope Scholarship higher education tax credit (Hope Credit). The Hope Credit is also temporarily renamed the American Opportunity Credit (Opportunity Credit). Under the revamped rules, the Opportunity Credit equals 100% of the first $2,000 of qualified post-secondary education expenses paid during the year plus 25% of the next $2,000. So the maximum annual credit is now $2,500. Under prior law, the maximum Hope Credit for 2009 was only $1,800, and it probably would be about the same for 2010.
The Opportunity Credit covers the cost of tuition, fees, and course materials (but not room and board) for the first four years of post-secondary education in a degree or certificate program. It is unavailable if the student has already completed four years worth of academic hours as of the beginning of that year. Under prior law, the Hope Credit was only allowed for the first two years of post-secondary study, and the cost of course materials did not count as a qualified expense.
The Opportunity Credit is only allowed for a year when the student carries at least half of a full-time load for at least one academic period beginning in that year (same as under the prior-law Hope Credit rules). Also, as under the prior law, married individuals who file separately are ineligible.
The Opportunity Credit is subject to phase-out rules, but they are considerably more lenient than the prior-law Hope Credit rules. The Opportunity Credit phase-out range for unmarried individuals is between modified adjusted gross income (MAGI) of $80,000 and $90,000. The phase-out range for married joint filers is between MAGI of $160,000 and $180,000. These ranges will also apply for 2010 without any inflation adjustments. Under the prior-law Hope Credit rules, the phase-out ranges for 2009 would have been $50,000 – $60,000 and $100,000 – $120,000, and the ranges for 2010 would probably remain the same. For this purpose, MAGI is defined as regular adjusted gross income (AGI) increased by income from outside the U.S. that was excluded from taxable income.
The Opportunity Credit is allowed to offset the taxpayer’s entire federal income tax liability, including any AMT. In addition, up to 40% of the Opportunity Credit can be refundable, meaning you can receive a refund even if you did not have taxes withheld or make any estimated payments. However, the refundability privilege is not allowed to taxpayers who fall under the dreaded Kiddie Tax rules (which can potentially hit students who are up to 23 years old as of year-end). Finally, special refundability limitations apply to residents of U.S. possessions (including the Commonwealths of Puerto Rico and the Northern Mariana Islands).
The new law doesn’t make any changes in the Lifetime Learning higher education tax credit (Lifetime Credit) rules. As you may know, the Lifetime Credit can be as much as $2,000 (based on 20% of up to $10,000 of qualified tuition and fees). As before, the Lifetime Credit can help offset graduate school tuition costs and tuition for non-degreed education such as professional education and certification courses.
Note that for 2009, the Lifetime Credit is phased out between MAGI of $50,000 and $60,000 for unmarried taxpayers and between MAGI of $100,000 and $120,000 for married joint-filing couples. Obviously, the phase-out ranges for the Opportunity Credit are considerably higher.