Two Tax Credits that Could Save You a Bundle

The following is a guest post from Harvey J. Poorbaugh, Editor of Fidelity Select Fundranker. It's actually a combination of two pieses he sent me, and I thought they worked best under the unified title above.

Making Work Pay Tax Credit for 2009 and 2010

The Making Work Pay tax credit for tax years 2009 and 2010 came about as part of the American Recovery and Reinvestment Act of 2009, which was signed into law by President Obama in February, 2009, to help stimulate the economy in the depths of the Great Recession.

Under the Making Work Pay tax credit, working people are supposed to receive up to $400 per year ($800 for married taxpayers filing jointly) of a refundable credit against their federal taxes.  Refundable means that if any remains after it is applied against your tax, it will result in a tax refund.  The Making Work Pay credit begins being phased out for single taxpayers at an AGI of $75,000 and for married taxpayers filing jointly at an AGI $150,000.

The whole idea of this tax credit was to get money in the hands of working people as soon as possible so they could spend it and stimulate the economy, so withholding tax tables were changed as of April 1, 2009, and workers started receiving a little bit more take home pay for the remainder of the year.  Those little bits, over the last nine months of 2009, as well as over the entire 12 months of 2010, should add up to about $400 ($800 for married taxpayers filing jointly).

When you fill out your 2009 federal tax return, and you get down to the Payments section of your Form 1040, you’ll put down your withholding, which should be about $400 ($800 for married taxpayers filing jointly) less than it would have been had the tax credit not existed, and then you’ll also put down $400 ($800 for married taxpayers filing jointly) for the tax credit.  So your tax payments should add up to about the same amount as they would have had the tax credit not existed, but Uncle Sam contributed $400 ($800 for married taxpayers filing jointly) of it for you.  He just gave the credit to you a little at a time during the year instead of giving it to you all at once when you file your tax return.

A few taxpayers may find that their employers cut their withholding too much during 2009.  If you have more than one job, or you and your spouse both work, remember that your different employers are unaware of your income from the others.  They simply look up your payroll withholding according to the number of allowances on your W-4 form. It was up to you to make sure that you claimed the appropriate number of allowances on your 2009 Form W-4 so that your employers didn’t cut your withholding too much during the year.  If you are unpleasantly surprised at how this works out on your 2009 tax return, make sure you update your 2010 Form W-4 right away.

Education Tax Credits for 2009

If you, your spouse, or one or more dependents had qualifying postsecondary education expenses in 2009, don’t miss claiming your education tax credit on federal Form 8863.  The American Opportunity credit is new for 2009, and the Hope and Lifetime Learning credits are still available, as well, although the Hope credit is useful now only if you need to claim qualifying educational expenses for a student who attended a school in a Midwestern disaster area.  Instead of the above education credits, you also still can claim the tuition and fees deduction on federal Form 8917 for 2009.  It is limited to $2,000 or $4,000 depending on your gross income less other deductions, is deducted from your gross income, and lowers your AGI.  As such, it hardly ever lowers your federal tax as much as the above credits, and we won’t discuss it any further.  As an aside, you may be able to reduce your state income tax for 2009 by claiming qualifying education expenses, as well.

The American Opportunity education credit, new for 2009, allows you to claim a tax credit of 100% of the first $2,000 and 25% of the next $2,000 of qualified education expenses for each student, for up to a maximum $2,500 tax credit per student, for the first four years of postsecondary education.  Even better, if you are at least 24 years old (see Form 8863 instructions if you were younger than 24 at the end of 2009), 40% of each student’s tax credit is refundable, meaning it will increase your tax refund, even if you don’t owe that much tax.  If you claim the American Opportunity credit for any student, you cannot claim the Hope credit for other students, but you can claim the Lifetime Learning credit for other students.  The American Opportunity credit is phased out beginning at $80,000 AGI for single taxpayers and $160,000 AGI for married taxpayers who file jointly.

If you have a student who attended school in a Midwestern disaster area, the Hope education credit allows you to claim a tax credit of 100% of the first $2,400 and 50% of the next $2,400 of qualified education expenses for each student, for up to a maximum $3,600 tax credit per student, for the first two years of postsecondary education.  If you have other students who did not attend school in a Midwestern disaster area, the Hope education credit allows you to claim a tax credit of 100% of the first $1,200 and 50% of the next $1,200 of qualified education expenses for each student, for up to a maximum $1,800 tax credit per student, for the first two years of postsecondary education.  If you claim the Hope credit for any student, you cannot claim the American Opportunity credit for other students, but you can claim the Lifetime Learning credit for other students.  None of the Hope credit is refundable, and it is phased out beginning at $60,000 AGI for single taxpayers and $120,000 AGI for married taxpayers who file jointly.

The Lifetime Learning education credit allows you to claim a tax credit of 20% (or 40%, if your student attended school in a Midwestern disaster area) of the first $10,000 of qualified education expenses for all students together, for up to a maximum $2,000 (or $4,000) tax credit.  This credit can be used for any number of years of postsecondary education.  None of it is refundable, and it is phased out beginning at $60,000 AGI for single taxpayers and $120,000 AGI for married taxpayers who file jointly.

Check various combinations of the three credits to see which is best for you.  For example, if you have only one student, she attended school in a Midwestern disaster area, and she had $10,000 of qualifying expenses, you could claim a $2,500 American Opportunity credit, a $3,600 Hope credit, or a $4,000 Lifetime Learning credit.  If you have two students, neither attended school in a Midwestern disaster area, and they each had $5,000 of qualifying expenses, you could claim a $5,000 American Opportunity credit, a $2,500 American Opportunity credit along with a $1,000 Lifetime Learning credit, or a $2,000 Lifetime Learning credit.  If you have two students, one attended school in a Midwestern disaster area and had $10,000 of qualifying expenses, and the other had $4,000 of qualifying expenses, you could claim a $5,000 American Opportunity credit for both students, a $5,400 Hope credit for both students, a $4,000 Lifetime Learning Credit for both students, or a $4,000 Lifetime Learning credit for the student who attended school in a Midwestern disaster area along with a $2,500 American Opportunity credit for the student who didn’t.

When you are figuring out which option is best for your situation, remember that, if the nonrefundable portion of your education credit is limited by the amount of your income tax, it’s possible a smaller American Opportunity credit, which is partly refundable, may be better than a larger Hope or Lifetime Learning credit.

Comments

[Crystal]

I will admit that my brain has hit it's wall...tax stuff always gets me.

What I would like to know is, what will this mean for us? My husband got his bachelor's degree in December 2004 (3 1/2 years total) and started his graduate degree in June 2009. We spent about $2000 in tuition for the first Summer Session of 2009 and $1000 in tuition for the second Summer Session of 2009. We then spent another $2000 for the Fall Semester of 2009 and paid $3000 for the Spring Semester of 2010 in advance.

Altogether, we spent about $8000 in tuition in 2009. We usually end up owing the IRS about $200-$400. How will these education credits effect our taxes?

I'll call our CPA tomorrow if no one knows off the top of their head...I'm just impatient. :-)

[Harvey J. Poorbaugh]

So your husband started his bachelor's degree in the fall semester, 2001, and finished in the fall semester, 2004, right? That may already count as the first four years of postsecondary education, so the Lifetime Learning credit seems to be right for you. Assuming your AGI is less than $120,000 (married, filing jointly), if he went to graduate school in a Midwestern disaster area (see IRS Publication 970 for a list) you should be able to claim 40% of the $8,000 of qualified expenses you mention, otherwise 20%. None of the Lifetime Learning credit is refundable, which means it is limited to your total tax. For example, if your total tax is $950, and you have withholding or estimated tax payments of $700, your Lifetime Learning credit of $1,600 (20%) or $3,200 (40%) will reduce the $950 to zero, and then you'll get a refund of your entire $700 withholding or estimated tax payments. Your husband's school should already have sent you a Form 1098-T to show your qualified expenses for 2009.

Since you paid ahead for the spring 2010 semester, those qualified expenses count for 2009. Whatever you actually spend on qualified education expenses in 2010 will count for your 2010 Lifetime Learning education credit.

[Money Mel]

This is also a good time to prepare for massive tax increases in 2011. Taxes are going up on income, capital gains, dividends and estates once January 1, 2011 hits. Be sure to check and see how your financial plan will be affected.

[Ben E.]

This post makes my brain hurt too... Do tax programs like TaxSlayer.com, TaxACT.com, TurboTax, and H&R Block calculate the best options automatically for you?

[Crystal]

Thanks Mr. Poorbaugh!

[Anonymous]

As far as the American Opp Credit for grad school - I paid about $3K in Federal taxes for the 1st half of 2009 before I left to attend school full time. Tuition was more than enough for me to qualify for the full credit. I am getting back about $3800 from Federal, which is amazing and makes me very happy. Usually I owe money.

I think the "first four years" thing refers to how many years you can claim it, not calendar years in school. I could be wrong, but I put my stuff in Turbo Tax and naturally grad school requires 4 years of college preceding it, and I still qualify.

[Travis]

@ Ben E.

As long as you enter you qualifying education expense and tuition (1098-T) into the program it should pick it up. However it always good to do a quick review to see if you it actually gave you the educational credit. Look for form 8863 when previewing your return and that should tell you if you received the credit.

On a side note. HR Block uses the software my company creates. It will pick up the credit and optimize between the credit and tuition/fees deduction...again as long as the information was entered in correctly by the preparer.

[Josh Stein]

Whatever you do and whatever your planning, remember that the goal is to be as close to breakeven as possible. You don't want to pay the IRS a whole lot (penalties & interest suck), and you don't want a huge refund (even the 1.2% at ING Direct right now is infinitely better than the 0% interest you get from the IRS on a current year return).

[Doug @ CheapScholar.org]

@Anonymous...

You can only claim the American Opportunity Credit during the 1st four tax years of undergraduate work. After that, you will switch over to the Lifetime Learning credit regardless of whether you are entering Grad School or a 6th year undergraduate senior..

When in doubt, read Publication Release 970. It spells out the qualifications and since the 2009 version was only released a week ago by the IRS, your Turbo Tax may not be up-to-date on all the details..

Hope this helps..

[MasterPo]

Guess that means Work [Doesn't] Pay for people making over $75k or couples making over $150k....