Many of you may have personally taken an education tax credit on a return at some point or perhaps have taken one for a child. Just as a quick refresher – there are two education tax credits currently available on your federal income tax return:
- American Opportunity Tax Credit. A potential credit of up to $2,500, with up to $1,000 being refundable, per student. This credit is only for the first four years of post-secondary education expenses.
- Lifetime Learning Credit. A potential credit of up to $2,000 per return, with no portion being refundable. This credit can be taken on any number of years for post-secondary education expenses.
To aid you or your tax accountant in calculating your credit, you likely received what is called a Form 1098-T. The form is issued to the taxpayer by the institution from which the costs were incurred. It reports to you the amount of qualified tuition and related expenses you paid during the tax year to that educational institution. If applicable, there may be an amount for scholarships or grants the student received reported on this form as well. Generally, scholarships will reduce the amount of qualified education expenses you can claim for the tax credit.
However, there is an opportunity available in the tax law that allows you to increase your education tax credit by picking up all or part of your scholarships or grants as income. Odd concept that including more income on your tax return would lower your overall tax liability, right? The idea is that the amount of the increase in your tax from the increase in your income is less than the increase in the tax credit received.
So, you are probably asking, how do you do this? Well, Regs. Sec. 125A-5(c)(3) states that scholarships and grants are excludable from taxable income under Sec. 117 except to the extent that the scholarship or grant may or must be applied to expenses other than qualified tuition and related expenses (room and board), and the student reports as income the correct portion of the scholarship or grant. To report the income on your tax return, you include the taxable portion on the “Wages, salaries, tips” line of your Form 1040. If not reported already on your W-2, enter “SCH” in the space to the left of the line. There is a good example in the Education Credit Form instructions on page 5.
As you can imagine, this may not be beneficial for all taxpayers, so you will need to determine the most advantageous amount to include in your income, if any. Another thing to consider is how this strategy may affect any educational assistance. Please consult your Henry+Horne tax advisor regarding which scholarships and grants along with education expenses will qualify for this strategy.
Kelsey L. Phillips, CPA