In order for this credit to be applicable, you or your dependent needs to be a qualifying student. A qualifying student is a student who is pursuing a degree or other recognized credential from a college or university and is enrolled at least half-time. Additionally the student must not have been convicted of a controlled substance felony.
As previously mentioned, qualified tuition and expenses are used to calculate the amount of the credit. Tuition and fees along with course materials (required books, supplies, etc.) are all qualified expenses and can be used to calculate the credit. However, things like insurance, room and board, and transportation are not considered qualified expenses. Another factor in calculating the credit is the amount of financial aid received. The college or university that you or your dependent is attending will send you a tuition statement (1098-T) which will report qualified expenses as well as financial aid received. The amount of qualified expenses reported on the tuition statement might just be the amount of tuition and fees paid/billed and therefore you might be able to tack on things like books and supplies that you were required to purchase for your courses. The total qualified educational expenses will be reduced by financial aid you receive like scholarships, fellowships, or grants, but will not be reduced by borrowed funds like student loans.
Form 8863 is used to calculate the credit and must be attached to your Form 1040 when you file your individual tax return. The form instructs you to start on Part III where you will calculate the amount of the credit. Then it will take you to Part I and then to finish up on Part II. Part I will calculate any phase-out of the credit that might take place based on your AGI (Adjusted Gross Income). Taxpayers that are married and filing jointly will begin to lose some of the credit if their AGI is above $160,000 and will completely miss out on the credit if their AGI reaches $180,000 or above. For taxpayers using the other filing statuses the credit will be limited if AGI reaches $80,000 and completely eliminated with an AGI of $90,000 or above. After the phase-out calculation, the refundable portion of the credit is calculated in Part I and then the nonrefundable portion is calculated in Part II.
In conclusion, it can be very advantageous to use education credits and deductions when preparing your tax return. Most of the time the American Opportunity Tax Credit will be the optimal credit to use, but if you don’t qualify, you can check to see if you qualify for the Lifetime Learning Credit or the Tuition and Fees Deduction. Education expenses are already high enough, you might as well use them to get some relief on your taxes and hopefully this post shed some light on how to do so.