Education Tax Credits

Education Tax Credits

And Other Educational Incentives

By Dana Bell, EA

Copyright © 2015 Dana Bell

Smashwords Edition

Copyright

Copyright © 2015 Dana Bell

No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law.

Smashwords Edition, License Notes

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Send book feedback to [email protected].

Dana Bell, EA

607 Pam Drive

Tyler, Texas

All product or company names that may be mentioned in this publication are trade names, trademarks or registered trademarks of their respective owners.

Colophon

This book was created in LibreOffice Writer and converted by Adobe Acrobat to a gray-scale PDF for publication on demand. Software images were captured using the Microsoft HTML Help Image Editor. The cover was created in Photoshop CS4. The ePub and derivatives were created in Sigil.

About the Type

The text uses 12 point Gentium Basic, a typeface from SIL International, formerly Southern Institute of Linguistics. It is a variation of the original Gentium font designed by Victor Gaultney. The headings were set in Franklin Gothic Book.

Table of Contents

Copyright

Alert

Preface

Being Informed

Additional Information

Information Requirement Unresolved

Reading Notes

The Basics

Overview

American Opportunity Tax Credit

Lifetime Learning Credit

Deductions

Benefit Comparison

Business Deduction for Work-Related Education

Employer-Provided Educational Assistance

No Double Benefit

General Scholarship Treatment

Regulations

Initial Regulations

Coordinating Scholarships and Grants to Maximize Credits

Pell Grants

Scholarship Research

Federal Grants

State Scholarships

Local Research Examples

Document Preparation

1098-T

UT Tyler

Tyler Junior College

Student Account Tabulation

Spreadsheet for Expense Calculations

Tax Credit Calculation

Calculating Expenses and Scholarships

Understanding Form 8863

Phase-out Calculations

Maximizing the Lifetime Learning Credit

Tax Preparation Techniques

Simple

Elective

Excess Complications

Family Coordination

Tax Bracket Watch

Software Solutions

Software Based Negligence

1098T Analysis and Inquiry

TaxWise

Intuit Pro Series (2012)

Lacerte

Drake (2013)

ATX (2012)

TaxSlayer (2013)

Others

Amending for Education Credits

Amending

IRS transcript

Special Issues

AGI

AOTC Phase-out:

Credit Offsets

Earned Income Tax Credit

Changes in EITC

Support

Education Credit Fraud

Common Education Credit Errors

1098-T

Documentation

Questions

Alternate Treatments

Resolving Tax Questions

Other Educational Incentives

Educational Savings

UTMA

IRAs

Employer-Provided Educational Assistance

Financial Aid

Student Loans

Education Planning

Timing Techniques

Coordinating Tax Credits With Other Benefits

Don’t Forget the Other Tax Benefits

Financial Advisors

Educational Planners

The Future of Education Credits

Congress

President

Schumer Proposal

Restrictions Proposed

AICPA

Conclusion

Appendices

Appendix A: Explaining the AOTC

Appendix B: The Education Credit Campaign

Appendix C: TIGTA Finding

Appendix D: Recommendation Letter on IRC § 25A(g)(8)

Index

About the Author

End Notes

Alert

In the previously published Education Tax Credit Essentials I indicated that taxpayers do not have to have a 1098-T in order to claim an education credit. Following the passage of H. R. 1295 that will no longer be the case. The new law was passed June 29, 2015 as part of the Trade Preferences Extension Act of 2015 and adds the following as IRC § 25A(g)(8):

PAYEE STATEMENT REQUIREMENT.—Except as otherwise provided by the Secretary, no credit shall be allowed under this section unless the taxpayer receives a statement furnished under section 6050S(d) which contains all of the information required by paragraph (2) thereof.

A similar requirement exists for the tuition deduction.

Note that the requirement does not take effect until the 2016 tax years for most individual taxpayers. A note in the bill Section 804(d) and the law (IRC § 25A) clarifies

Effective Date.--The amendments made by this section shall apply to taxable years beginning after the date of the enactment of this Act.

While taxpayers will be required to have a 1098-T following 2016, institutions are often not required to provide one. Until that is remedied, many taxpayers could be deprived of an education credit or deduction they would have otherwise been qualified for. I anticipate that the IRS will issue new regulations to reconcile the discrepancy.

Preface

In 2014 the Department of Treasury released a 4-page document explaining in part, how taxpayers can coordinate their Pell grant with qualifying expenses to maximize their education credit. That document also has a section that explains how to help with the appeal to inform students that they have a choice in how to allocate Pell Grants for tax purposes.

The IRS has been attempting to educate taxpayers on the subject of education tax credits and scholarship inclusion for years. Pub 970 has discussed this in the past, but now the encouragement has been added to the 8863 instructions and in 2015 will be included on the back of the 1098-T.

Not only do students need to be aware of the potential of Pell grants and educational expenses, so do their parents, educational institutions, financial planners, and tax professionals. While I am not responding to that particular appeal to inform others, I am using this text to try to encourage others, with a focus on tax professionals, to learn more about education tax credits.

Being Informed

Education credits were first introduced in 1998 but they have been expanded or extended three times. The AOTC is now good until 2017 but it will likely be extended or expanded again before that expiration.

Many tax professionals bemoan the complexity of education incentives but the biggest problem of taxpayers is being informed concerning education tax credits and other assistance. And it’s not just that they don’t have the information, much of the information that is being presented is wrong, grossly incomplete, or outdated. Getting tax professionals informed is thus the primary purpose of this book.

Lack of Information

One of the most popular sites for education-related information is www.1098-T.com, primarily because they deliver electronic versions of the 1098-T, the form often used to report expenses for the credit. The information provided on that site for the American Opportunity Tax Credit includes the statement,

... higher education expenses paid with a tax-free scholarship, Pell Grant or employer-provided educational assistance cannot be used when figuring your education credits. Eligible expenses for this credit are offset by scholarships, grants, and other tax-free tuition benefits.¹

While this may be true, the lack of additional information makes this misleading.

Other sources of education credit information comes from big box tax chains like H&R Block² and TurboTax3. The mantra is that tax-free amounts you use to cover expenses cannot be used to claim the credits. That’s true, but it’s not the whole truth. These tax chains often employ minimally trained preparers, and focus on only the simplest and most basic returns, and routine credits like the EITC. Even if they knew, they may not know how to do it right.

Misinformation

This lack of information further leads to misinformation and one of the biggest sources of misinformation is from institutions. Treasury Regulations allow institutions to forego providing students a 1098-T when financial aid exceeds qualified expenses. That has led many institutions to believe that students do not qualify for an education credit in those cases. Tyler Junior College, our local junior college indicates that if you didn’t get a 1098-T, you don’t qualify for an education credit.

Outdated Information

Web resources that provide education credit information often include disclaimers that indicate that the information does not constitute tax advice, but many times the statements are grossly incomplete.

Not only is scholarship inclusion information not included but many sites only mention the Hope Scholarship which covers 2 years and have nothing about the American Opportunity Tax Credit (passed in 2008). One such site is collegeforalltexans.com (Copyright © 2015 Texas Higher Education Coordinating Board) which only lists the Hope Tax Credit.⁴

Mixed Signals

Sometimes you can get mixed signals from the same company or organization. Although information is often incomplete, incorrect, or outdated, there are cases where more accurate information is available from the same entity.

The IRS is well-known for giving conflicting advice. While instructions indicate taxpayers can include scholarships in income to increase education credits, not every IRS employee will tell you that. Even presenters in IRS webinars have used the argument that expenses must be paid out of pocket, though none of the IRS instructions include that requirement.

Many H&R Block sites will not know about scholarship re-characterization, but the Tax Institute at H&R Block does have it right at http://blogs.hrblock.com/2014/08/26/federal-student-aid-what-are-the-tax-consequences/, at least in reference to Pell grants.

Alternate Treatments

The latest obstacle to being informed about education tax credits is in the use of alternate treatments and interpretations. Entities are learning about the opportunities but are reluctant to take advantage of them, so they add additional restrictions as safeguards against inappropriate claims.

Meeting the Challenges

The theory of education credits is really simple. Taxpayers can earn a credit for amounts paid for qualifying expenses. The tax code and regulations concerning education tax credits are also relatively straightforward. In practice, however, education credits present a number of challenges. The first challenge is understanding how scholarships and grants come into play and the differences between scholarships. The second challenge is determining qualifying expenses as the document that contains that information may not be complete or accurate. Another challenge involves coordinating the tax credits with other benefits and other aspects of the tax return. The final challenge is educating clients about education credits. Educating clients may be the first step in the preparation, but professionals first need to have a firm grip on education credits and the many ramifications of financing education.

Book Outline

The goal of this text is to help you meet these challenges by enabling you to plan the process of calculating education credits. Following are the basics you need to know to prepare returns with education credits, tasks that I address in the first part of the book.

Understanding the Education Credits

Understanding the Regulations

Researching Scholarships

Document Preparation

Student Account Tabulation

Tax Credit Calculation

Additionally there are some suggestions for more efficient processes, effective strategies, and tax planning opportunities presented in the second part of the book.

Tax Preparation Techniques

Software Solutions

Special Issues

Documentation

Planning and Coordination

Amending for Education Credits

There are only two education credits under the current tax code and this book focuses primarily on the American Opportunity Tax Credit. Brief discussions of the Lifetime Learning Credit and various deductions are also included.

This text started as a series of articles on the blog Switched Keys describing how to claim education credits. The articles and other resources are also part of an AOTC toolkit that can be downloaded from www.tylerhosting.com/EdCredit/.

Additional Information

A prior edition of this book was published in May providing the above essentials needed to claim education credits. This is the expanded version of the text which includes additional fluff that may interest other readers.

This version of Education Tax Credits includes information on these other forms of educational assistance.

Educational Savings Accounts (Section 529, Coverdell)

IRAs used for educational expenses

Employer-Provided Educational Assistance

Financial Aid

Student Loans

While tax credits and deductions may be popular among lower-income taxpayers, high-earning taxpayers are more likely to be interested in things like Section 529 and Coverdell savings accounts, so I’ve discussed them in more detail in this version. While tax credits can be claimed as an afterthought, these other tax incentives require a considerable amount of forethought.

General information is also presented on how to combine the different forms of educational assistance to optimize educational expenses. This version also closes with a look at the future of educational credits. Appendices include information on related topics such as my education credit campaign and a discussion of the TIGTA study of tax credits and suspected fraud.

Comments, questions, and corrections are welcome and can be submitted through the contact form on the blog, or directly to [email protected]. I have discovered a couple of issues during the writing and publishing process and I am sure I have omitted information that you might think useful and relevant. Let me know.

Information Requirement Unresolved

One thing that still remains unresolved concerning education credits is the reconciliation of new education credit requirements and the reporting requirements of educational institutions. Currently, taxpayers are generally not required to have a 1098-T in order to claim an education credit. For tax years starting after the passing of H. R. 1295, taxpayers are required to have this form in order to claim the credit.

(8) Payee statement requirement

Except as otherwise provided by the Secretary, no credit shall be allowed under this section unless the taxpayer receives a statement furnished under section 6050S(d) which contains all of the information required by paragraph (2) thereof.

A note clarifies the timing of this requirement as the tax year following enactment (Pub. L. 114–27, title VIII, § 804(d)).⁵

Effective Date.--The amendments made by this section shall apply to taxable years beginning after the date of the enactment of this Act.

The difficulty is that currently institutions are not always required to provide the 1098-T. Individual taxpayers generally use a calendar year, so the effective date would be January 1, 2016 for returns due by April 15, 2017.

Reading Notes

Footnotes

Generally, footnotes are restricted to external sources other than references to the tax code or regulations. Links for most of the external websites are likewise included in the footnotes.

Tax Code and Regulations

Code sections and references to Treasury Regulations are generally provided in the text, usually at the end of relevant