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Erase tax timing mistakes with education credits

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in Small Business Tax

If you qualify under special income limits, you can defray some college costs with an education tax credit. But it’s not only how much you pay that counts, it’s also when you pay it.

Strategy: Don’t prepay tuition for next year if you’ve already maxed out on the credit this year. Assuming that you’ll still qualify, save the payment for next year. Otherwise, you’ll forfeit a big tax credit. This is particularly important if your child is entering his or her senior year.

Here’s the whole story: You may be able to claim either the Hope Scholarship tax credit or the Lifetime Learning tax credit for a college student. The maximum Hope Scholarship credit is $1,650 per student for each of the first two years of school. The Lifetime Learning credit equals 20 percent of the first $10,000 of qualified tuition expenses for any year that the Hope credit isn’t claimed.

For 2006, both credits phase out at an adjusted gross income (AGI) between $45,000 and $55,000 for unmarried filers; $90,000 to $110,000 for joint filers.

New case: A married couple paid the tuition for their niece—a dependent—to attend college. In the tax year in dispute, the couple prepaid at the end of 2001 for their niece’s 2002 spring semester that began in January of that year.

On their 2002 tax return, the couple claimed the Lifetime Learning credit for the tuition payment made in the prior year.

But the Tax Court said it’s the payment date—not the time when the child is attending school—that counts. Therefore, the couple lost out on the credit. (Patel, TC summary opinion 2006-40)

Tip: If you’re eligible for either education tax credit, try to keep your annual AGI below the phaseout levels.

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