How Lifetime Learning Tax Credits Work

The eligibility requirements for the Lifetime Learning Tax Credit are published by the Internal Revenue Service (IRS). Since the IRS has a habit of making things more complicated than necessary, we'll do our best to explain it simply.

To be eligible for the credit, you need to have paid "qualified educational expenses" at an "eligible postsecondary institution." This is easier than it sounds. Qualified educational expenses are things like tuition and any other required costs or fees like books or equipment. The only catch: If the expense isn't required for enrollment, it doesn't qualify [source: IRS].

As for "eligible postsecondary institutions," just about every undergraduate, graduate, professional or vocational school in the country qualifies [source: IRS]. That includes all public, private and nonprofit institutions that participate in a student aid program administered by the U.S. Department of Education. If you have questions, ask your school if it qualifies.

The nice part is that the tax credit is calculated on a "per family" basis, which means spouses and dependents can claim educational expenses on the same tax return [source: IRS]. For example, if both you and your dependent son are taking classes during the same academic year, you can claim a tax credit against the total amount of both your expenses.

There's a catch, of course. You can only claim the Lifetime Learning Tax Credit if you earn less than $58,000 a year as an individual or less than $116,000 if married and filing jointly. You can't claim the credit if you're married and filing separately, no matter how little you earn [source: IRS].

The income amount is based on something called the modified adjusted gross income (MAGI). This sounds scarier than it is. For most taxpayers, the MAGI is exactly the same as the adjusted gross income (AGI), the amount you've earned before subtracting any standard or itemized deductions. For a small percentage of taxpayers, the MAGI is "modified" to include extra income or special deductions like foreign income, foreign-housing deductions, IRA contribution deductions and higher-education deductions [source: Investopedia].

Here comes the fun part: filling out those dreadful IRS forms. We'll walk you through the process of claiming the Lifetime Learning Tax Credit on the next page.

Under the terms of the Lifetime Learning Tax Credit, you're allowed to claim 20 percent of your total educational expenses for the year up to $10,000. That means the maximum tax credit is $2,000. However, a special provision allows residents of the "Midwestern disaster areas" affected by flooding and tornadoes in 2008 to claim 40 percent of expenses up to $10,000 for a maximum claim of $4,000. Click here for a list of counties included in the Midwestern disaster areas.

You can claim educational expenses paid for any class taken during the past year and the first three months of the current year. For example, if you paid tuition in December 2009 for classes that didn't start until March 2010, you can still claim the expenses on your 2009 taxes.

It's important to keep detailed records of your educational expenses. If you lost your receipts or invoices, ask your school for another copy. Your school is required by law to provide itemized invoices for all educational expenses [source: IRS].

Your school is also required to send you an IRS Form 1098-T by February 2. This is where your school reports all of the expenses that it has received from you along with any scholarships, grants, reimbursements or refunds. (Note: You aren't required to use the figures sent by your school when you report your expenses. You should use the most accurate numbers that your records indicate [source: IRS].)

To claim the Lifetime Learning Tax Credit, you must fill out Part III of the IRS Form 8863 and include it with your regular 1040 income tax return. The form is relatively straightforward, but it does require that you know your MAGI. If you're filing Form 1040A, then your MAGI is the same as your AGI on line 22. If you're filing a Form 1040, then you can calculate your MAGI using worksheet 3-1 [source: IRS].

Keep in mind that not everyone with income below $58,000 receives the full tax credit. If your MAGI is between $48,000 and $58,000 ($96,000 and $116,000 if you file jointly), then you will receive a "phased out" amount. The higher your income, the less you will receive. The phased out amount is calculated in Part V of Form 8863.

IRS Form 8863 is also where you would apply for the American Opportunity Credit. Note that the same individual isn't allowed to apply for both credits, but the same family is [source: IRS]. For example, you can apply for the Lifetime Learning Tax Credit and your dependent son can apply for the American Opportunity Credit.

For more higher education resources, visit the links on the next page.