Income-Related Phaseout of Education Credits

Unfortunately, the American Opportunity credit and Lifetime Learning credit are phased out for those at higher income levels.

Warning Although either the student or the parent (but not both) can claim the American Opportunity or Lifetime Learning credit, you can't avoid the high-income phaseouts for either of these credits by having the student claim the credit, unless the student cannot be claimed as a dependent on the parent's tax return.

The 2011 phaseout begins at modified adjusted gross income of $80,000 for singles and $160,000 for marrieds filing a joint return. To determine whether your credit will be affected by the phaseout, you must compute your modified adjusted gross income: your AGI as shown on Line 37 of Form 1040 (or Line 21 on Form 1040A), plus any foreign earned income exclusion, plus amounts derived from sources in American possessions if you are a resident of the possession (Guam, American Samoa, the Northern Mariana Islands, or Puerto Rico).

The phaseout is computed by reducing the amount of your credit by a fraction. The fraction is found by taking the amount of your modified AGI that exceeds $80,000 (or $160,000, if filing jointly) and dividing it by $10,000 (or by $20,000 if filing jointly). Thus, the credit is fully phased out at MAGI of $90,000 for single filers and $180,000 for married filing jointly.

Example Steve and Kit are married filing jointly, and have twin sons who are both freshmen in college in 2010. For each of the boys, tuition costs exceed $4,000. Steve and Kit would normally have an American Opportunity credit of $2,500 for each son, or $5,000 in total. However, their AGI is $164,000, so they must reduce their credit as follows: Their AGI exceeds $160,000 by $4,000, and they divide $4,000 by $20,000 to get a fraction of 1/5. Therefore, 1/5 of their credit will not be allowed, and they can claim a Hope credit of only $4,000 for 2011.

Claiming the Credit

To claim the American Opportunity credit (or the Lifetime Learning credit) you must complete IRS Form 8863, Education Credits, and attach it to your Form 1040 or 1040A. These credits are subtracted from your tax bill after the foreign tax credit and the credit for child and dependent care expenses. If these credits reduce your tax bill to zero, you will lose any unused amount of the education credits, because they may not be carried over into a subsequent year.

For 2011, there is an important exception to the "use it or lose it" rule just described. The law enacting the American Opportunity credit allows 40 percent of that credit to be refunded to you even if you have no tax liability. Thus, if your tax liability is zero in 2011, but you have an American Opportunity credit of $2,500, you can claim a $1,000 refund.