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Education: What tax incentives exist to help families pay for college? Rapidly rising college expenses in the 1990s spurred the 1997 enactment of tax incentives for higher education: the Hope Credit, the Lifetime Learning Credit, and a deduction for tuition and fees. As a consequence, federal tax subsidies for college students rose from zero before enactment to roughly $6 billion in 2005-06. Other tax incentives encourage families to save for college (see Taxation of the Family: What tax incentives exist to help families save for college?). The American Recovery and Reinvestment Tax Act of 2009 temporarily replaced the Hope Credit with the partially refundable American Opportunity Tax Credit (AOTC), increasing the amount of expenses eligible for the credit, extending coverage to the first four years of school (up from the first two years allowed by the Hope credit), expanding the types of expenses allowable for the credit, and making the credit partially refundable so it is available to more low-income students. Taxpayers may claim the new credit for 2009 and 2010 only. The President's 2011 budget proposes extending the AOTC through 2011. Before Congress created the AOTC, critics complained that the tax benefits had not had much effect on college enrollment, but rather had provided subsidies to people who are likely to attend college anyway. Many low-income students who might be most influenced by reduced college costs could get little or no benefit from the Hope and LLC credits because they are nonrefundable and thus can only offset income taxes owed. At the other end of the income scale, the credits are phased out for many high-income families. As a result, the largest average benefits go to families with annual incomes between $30,000 and $100,000. The impact of making the credit refundable is not yet known. Unless Congress acts to extend it, the AOTC will expire after 2010 and the Hope Credit will be restored. - For each student, families may claim only one of the three tax benefits but they need not claim the same benefit for all students. Complexity associated with having to choose which benefit to take results in people frequently choosing sub-optimally (GAO 2005).
- The American Opportunity Tax Credit applies to tuition, fees, and required books for students enrolled at least half time in their first four years of college. The credit equals 100 percent of the first $2,000 of eligible expenses plus 25 percent of the next $2,000, yielding an annual maximum credit of $2,500 when qualifying expenses are at least $4,000. Forty percent of the credit is refundable and thus available to all students, regardless of their tax liability. Each qualifying student in the household may receive the AOTC.
- The Lifetime Learning Credit equals 20 percent of tuition and fees for any post-secondary education, up to a maximum annual credit of $2,000. That maximum applies to the combined expenses of all students in the household claiming the credit and is reached when total qualifying expenses reach $10,000.
- The maximum benefit for the American Opportunity Tax Credit phases out between adjusted gross income $80,000 and $90,000 (between $160,000 and $180,000 for married couples). The maximum benefit for the Lifetime Learning Credit phases out between adjusted gross incomes of $45,000 and $55,000 for single taxpayers, or between $90,000 and $110,000 for married couples.
- The deduction for tuition and fees allows taxpayers (parents or students, whichever pays) to reduce taxable income by up to $4,000. To qualify, a family’s adjusted gross income may not exceed $65,000 for single filers or $130,000 for married filers. Single filers with AGI between $65,000 and $80,000 or married filers with AGI between $130,000 and $160,000 can deduct up to $2,000 of expenses. After that, a family is no longer eligible for the deduction. The tuition and fees deduction is scheduled to expire after 2009.
- Most people who qualify for a tax credit for education expenses will benefit more from the American Opportunity Tax Credit than the Lifetime Learning Credit by virtue of the AOTC being the larger of the two. Students who do not qualify for the AOTC – those who are less than half-time, or are in their fifth year of school, for example – will benefit more from the LLC.
- The Lifetime Learning Credit is nonrefundable, so only people who owe income tax can benefit. Similarly, the deduction for tuition and fees is valuable only for people with taxable income.
- Prior to the enactment of the American Opportunity Tax Credit, the education tax programs provide relatively modest benefits: an average of $771 per household. Average benefits are highest for those receiving a Hope Credit ($1,069), followed by the Lifetime Learning Credit ($978), and finally the tuition and fees deduction ($324). Average benefits under the American Opportunity Tax Credit will be higher.
- Using the tax system to subsidize higher education has two primary advantages: Students need not fill out the complicated Free Application for Federal Student Aid form, and every student who qualifies receives a benefit.
Possible options for reform - Even though some books are now eligible expenses for the American Opportunity Tax Credit (as opposed to only tuition and fees for the Lifetime Learning Credit), additional assistance could be provided by broadening coverage to include more expenses such as room and board.
- Providing benefits directly to schools when students enroll (based on the previous year’s taxes) would help students cover college costs when they actually have to make payments, not months later when their families file tax returns.
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