IRS Releases Publication 970 (2016), Tax Benefits for Education

Future Developments

For the latest information about developments related to Pub. 970, such as legislation enacted after it was published, go to http://www.irs.gov/pub970.

What's New

Form 1098-T requirement. For tax years beginning after June 29, 2015, generally tax year 2016 returns for most taxpayers, the law requires a taxpayer (or a dependent) to have received a Form 1098-T from an eligible educational institution in order to claim the tuition and fees deduction, American opportunity credit, or the lifetime learning credit. However, for tax year 2016, a taxpayer may claim one of these education benefits if the student does not receive a Form 1098-T because the student's educational institution is not required to send a Form 1098-T to the student under existing rules (for example, if the student is a nonresident alien, has qualified education expenses paid entirely with scholarships, or has qualified education expenses paid under a formal billing arrangement). If a student's educational institution is not required to provide a Form 1098-T to the student, a taxpayer may claim one of these education benefits without a Form 1098-T if the taxpayer otherwise qualifies, can demonstrate that the taxpayer (or a dependent) was enrolled at an eligible educational institution, and can substantiate the payment of qualified tuition and related expenses.

Ban on claiming the American opportunity credit. If you claim the American opportunity credit even though you're not eligible, you may be banned from claiming the credit for up to 10 years. See the Caution statement under Introduction in chapter 2.

Taxpayer identification number needed by due date of return. If you don't have a taxpayer identification number (TIN) by the due date of your 2016 return (including extensions), you can't claim the American opportunity credit on either your original or an amended 2016 return, even if you later get a TIN. Also, the American opportunity credit isn't allowed on either your original or an amended 2016 return for a student who doesn't have a TIN by the due date of your return (including extensions), even if that student later gets a TIN.

Lifetime learning credit. For 2016, the amount of your lifetime learning credit is gradually reduced (phased out) if your modified adjusted gross income (MAGI) is between $55,000 and $65,000 ($111,000 and $131,000 if you file a joint return). You can't claim a credit if your MAGI is $65,000 or more ($131,000 or more if you file a joint return). For more information, see chapter 3. The American opportunity credit MAGI limits are unchanged (see chapter 2).

Student loan interest deduction. For 2016, the amount of your student loan interest deduction is gradually reduced (phased out) if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if you file a joint return). You can't claim the deduction if your MAGI is $80,000 or more ($160,000 or more if you file a joint return). See chapter 4 for more information.

Education savings bond program. For 2016, the amount of your education savings bond interest exclusion is gradually reduced (phased out) if your MAGI is between $77,550 and $92,550 ($116,300 and $146,300 if you file a joint return). You can't exclude any of the interest if your MAGI is $92,550 or more ($146,300 or more if you file a joint return). See chapter 10 for more information.

Business deduction for work-related education. For 2016, if you drive your car to and from school and qualify to deduct transportation expenses, the amount you can deduct for miles driven from January 1, 2016, through December 31, 2016, is 54 cents a mile. See chapter 12 for more information.

Reminders

Form 1098-T, Tuition Statement. When figuring an education credit or tuition and fees deduction, use only the amounts you paid and are deemed to have paid during the tax year for qualified education expenses. In most cases, the student should receive Form 1098-T from the eligible educational institution by January 31, 2017. An institution may choose to report either payments received during calendar year 2016 (box 1), or amounts billed during the calendar year 2016 (box 2), for qualified education expenses. However, the amounts on Form 1098-T, boxes 1 and 2, might be different than the amount you actually paid and are deemed to have paid. In addition, the Form 1098-T should give you other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements, or refunds, and whether the student was enrolled at least half-time or was a graduate student. The eligible educational institution may ask for a completed Form W-9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification, or similar statement to obtain the student's name, address, and taxpayer identification number.

Coordination with Pell grants and other scholarships or fellowship grants. It may benefit you to choose to include otherwise tax-free scholarships or fellowship grants in income. This may increase your education credit and lower your total tax or increase your refund. See Coordination with Pell grants and other scholarships or fellowship grants throughout this publication.

Hope scholarship credit. For 2016, the Hope scholarship credit isn't available. However, you may be able to claim an American opportunity or lifetime learning credit. See chapter 2 and chapter 3 for more information.

Achieving a Better Life Experience (ABLE) account. This is a savings account for individuals with disabilities and their families. Distributions are tax free if used to pay the beneficiary's qualified disability expenses, which may include education expenses. For more information, see Pub. 907, Tax Highlights for Persons With Disabilities.

Estimated tax payments. If you have taxable income from any of your education benefits and the payer doesn't withhold enough income tax, you may need to make estimated tax payments. For more information, see Pub. 505, Tax Withholding and Estimated Tax.

Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.

Introduction

This publication explains tax benefits that may be available to you if you are saving for or paying education costs for yourself or, in many cases, another student who is a member of your immediate family. Most benefits apply only to higher education.

What is in this publication. Chapter 1 explains the tax treatment of various types of educational assistance, including scholarships, fellowship grants, and tuition reductions.

Two tax credits for which you may be eligible are explained in chapter 2 and chapter 3. These benefits, which reduce the amount of income tax you may have to pay, are:

Comparison table. Some of the features of these benefits are highlighted in Appendix B, later, in this publication. This general comparison table may guide you in determining which benefits you may be eligible for and which chapters you may want to read.

TIP: When you figure your taxes, you may want to compare these tax benefits so you can choose the method(s) that gives you the lowest tax liability. If you qualify, you may find that a combination of credit(s) and deduction(s) gives you the lowest tax.

Analyzing your tax withholding. After you estimate your education tax benefits for the year, you may be able to reduce the amount of your federal income tax withholding. Also, you may want to recheck your withholding during the year if your personal or financial situation changes. For more information, see Pub. 505, Tax Withholding and Estimated Tax.

Glossary. In this publication, wherever appropriate, we have tried to use the same or similar terminology when referring to the basic components of each education benefit. Some of the terms used are:

Many of the terms used in the publication are defined in the glossary near the end of the publication. The glossary isn't intended to be a substitute for reading the chapter on a particular education benefit, but it will give you an overview of how certain terms are used in discussing the different benefits.

Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions.

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Tax questions. If you have a tax question not answered by this publication, check IRS.gov and How To Get Tax Help at the end of this publication.

Useful Items

You may want to see:

Publication

1. Scholarships, Fellowship Grants, Grants, and Tuition Reductions

Reminder

Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. Under this rule, a taxable scholarship or fellowship grant is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. For more information about IRAs, see Pub. 590-B.

Introduction

This chapter discusses the income tax treatment of various types of educational assistance you may receive if you are studying, teaching, or researching in the United States. The educational assistance can be for a primary or secondary school, a college or university, or a vocational school. Included are discussions of:

Special rules apply to U.S. citizens and resident aliens who have received scholarships or fellowship grants for studying, teaching, or researching abroad. For information about these rules, see Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Scholarships and Fellowship Grants

A scholarship is generally an amount paid or allowed to, or for the benefit of, a student (whether an undergraduate or a graduate) at an educational institution to aid in the pursuit of his or her studies.

A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.

Amount of scholarship or fellowship grant. The amount of a scholarship or fellowship grant includes the following.

A scholarship or fellowship grant is tax free (excludable from gross income) only if you are a candidate for a degree at an eligible educational institution.

TIP: You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. See examples in Coordination with Pell grants and other scholarships, in chapter 2 and chapter 3.

A scholarship or fellowship grant is tax free only to the extent:

Worksheet 1-1. Taxable Scholarship and Fellowship Grant Income

 Keep for Your Records

Qualified education expenses. For purposes of tax-free scholarships and fellowship grants, these are expenses for:

Exceptions. You don't have to treat as payment for services the part of any scholarship or fellowship grant that represents payment for teaching, research, or other services if you receive the amount under:

Example 2. You are a candidate for a degree at a medical school. You receive a scholarship (not under any of the exceptions mentioned above) for your medical education and training. The terms of your scholarship require you to perform future services. A substantial penalty applies if you don't comply. The entire amount of your grant is taxable as payment for services in the year it is received.

Athletic Scholarships

An athletic scholarship is tax free only if and to the extent it meets the requirements discussed earlier.

Worksheet 1-1. You can use Worksheet 1-1 to figure the tax-free and taxable parts of your athletic scholarship.

Taxable Scholarships and Fellowship Grants

If and to the extent your scholarship or fellowship grant doesn't meet the requirements described earlier, it is taxable and must be included in gross income. You can use Worksheet 1-1 to figure the tax-free and taxable parts of your scholarship or fellowship grant.

Reporting Scholarships and Fellowship Grants

Whether you must report your scholarship or fellowship grant depends on whether you must file a return and whether any part of your scholarship or fellowship grant is taxable.

If your only income is a completely tax-free scholarship or fellowship grant, you don't have to file a tax return and no reporting is necessary. If all or part of your scholarship or fellowship grant is taxable and you are required to file a tax return, report the taxable amount as explained below. You must report the taxable amount whether or not you received a Form W-2. If you receive an incorrect Form W-2, ask the payer for a corrected one.

For information on whether you must file a return, see Pub. 501, Exemptions, Standard Deduction, and Filing Information, or your income tax form instructions.

How To Report

How you report any taxable scholarship or fellowship grant income depends on which return you file.

Form 1040EZ. If you file Form 1040EZ, include the taxable amount in the total on line 1. If the taxable amount was not reported on Form W-2, also enter "SCH" and the taxable amount in the space to the left of line 1.

Form 1040A. If you file Form 1040A, include the taxable amount in the total on line 7. If the taxable amount was not reported on Form W-2, also enter "SCH" and the taxable amount in the space to the left of line 7.

Form 1040. If you file Form 1040, include the taxable amount in the total on line 7. If the taxable amount was not reported on Form W-2, also enter "SCH" and the taxable amount on the dotted line next to line 7.

Form 1040NR. If you file Form 1040NR, report the taxable amount on line 12. Generally, you must report the amount shown on Form(s) 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, box 2. See the Instructions for Form 1040NR for more information.

Form 1040NR-EZ. If you file Form 1040NR-EZ, report the taxable amount on line 5. Generally, you must report the amount shown on Form(s) 1042-S, box 2. See the Instructions for Form 1040NR-EZ for more information.

Other Types of Educational Assistance

The following discussions deal with other common types of educational assistance.

Fulbright Grants

A Fulbright grant is generally treated as a scholarship or fellowship grant in figuring how much of the grant is tax free.

Pell Grants and Other Title IV Need-Based Education Grants

These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax free to the extent used for qualified education expenses during the period for which a grant is awarded.

Payment to Service Academy Cadets

An appointment to a United States military academy isn't a scholarship or fellowship grant. Payment you receive as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to you on Form W-2, box 1. Include this pay in your income in the year you receive it unless one of the exceptions, discussed earlier under Payment for services, applies.

Veterans' Benefits

Payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. Don't include these payments as income on your federal tax return.

If you qualify for one or more of the education tax benefits discussed in chapters 2 through 12, you may have to reduce the amount of education expenses qualifying for a specific tax benefit by part or all of your VA payments. This applies only to the part of your VA payments that is required to be used for education expenses.

You may want to visit the Veterans Administration website at http://www.gibill.va.gov for specific information about the various VA benefits for education.

Example. You have returned to college and are receiving two education benefits under the latest GI Bill: (1) a $1,534 monthly basic housing allowance (BHA) that is directly deposited to your checking account, and (2) $3,840 paid directly to your college for tuition. Neither of these benefits is taxable and you don't report them on your tax return. You also want to claim an American opportunity credit on your return. Your total tuition charges are $5,000. To figure the amount of credit, you must first subtract the $3,840 from your qualified education expenses because this payment under the GI Bill was required to be used for education expenses. You don't subtract any amount of the BHA because it was paid to you and its use wasn't restricted.

Qualified Tuition Reduction

If you are allowed to study tuition free or for a reduced rate of tuition, you may not have to pay tax on this benefit. This is called a "tuition reduction." You don't have to include a qualified tuition reduction in your income.

A tuition reduction is qualified only if you receive it from, and use it at, an eligible educational institution. You don't have to use the tuition reduction at the eligible educational institution from which you received it. In other words, if you work for an eligible educational institution and the institution arranges for you to take courses at another eligible educational institution without paying any tuition, you may not have to include the value of the free courses in your income.

The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education.

You must include in your income any tuition reduction you receive that is payment for your services.

Eligible educational institution. An eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

Officers, owners, and highly compensated employees. Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, officers, or highly compensated employees.

Payment for services. Generally, you must include in income the part of any qualified tuition reduction that represents payment for teaching, research, or other services by the student required as a condition of receiving the qualified tuition reduction. This applies even if all candidates for a degree must perform the services to receive the degree. (See below for exceptions.)

Exceptions. You don't have to include in income the part of any scholarship or fellowship grant that represents payment for teaching, research, or other services if you receive the amount under:

If you receive a tuition reduction for education below the graduate level (including primary, secondary, or high school), it is a qualified tuition reduction, and therefore tax free, only if your relationship to the educational institution providing the benefit is described below.

Child of divorced parents. For purposes of the qualified tuition reduction, a dependent child of divorced parents is treated as the dependent of both parents.

Graduate Education

A tuition reduction you receive for graduate education is qualified, and therefore tax free, if both of the following requirements are met.

How To Report

Any tuition reduction that is taxable should be included as wages on your Form W-2, box 1. Report the amount from Form W-2, box 1, on line 7 (Form 1040A) or line 1 (Form 1040EZ).

2. American Opportunity Credit

Introduction

For 2016, there are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. They are the American opportunity credit (this chapter) and the lifetime learning credit (chapter 3).

This chapter explains:

A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. Forty percent of the American opportunity credit may be refundable. This means that if the refundable portion of your credit is more than your tax, the excess will be refunded to you.

Your allowable American opportunity credit may be limited by the amount of your income. Also, the nonrefundable part of the credit may be limited by the amount of your tax.

Overview of the American opportunity credit for 2016. See Table 2-1 for the basics of this credit. The details are discussed in this chapter.

Table 2-1. Overview of the American Opportunity Credit for 2016

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If you pay qualified education expenses for more than one student in the same year, you can choose to claim the American opportunity credit on a per-student, per-year basis. If you pay qualified education expenses for a student (or students) for whom you don't claim the American opportunity credit, you can use the adjusted qualified education expenses of that student (or those students) in figuring your lifetime learning credit. This means that, for example, you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year.

Differences between the American opportunity and lifetime learning credits. There are several differences between these two credits. For example, you can claim the American opportunity credit based on the same student's expenses for no more than 4 tax years, which includes any tax years you claimed the Hope scholarship credit for that student. However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. The differences between these credits are shown in Appendix B near the end of this publication.

TIP: If you claim the American opportunity credit for any student, you can choose between using that student's adjusted qualified education expenses for the American opportunity credit or the lifetime learning credit. If you have the choice, the American opportunity credit will always be greater than the lifetime learning credit.

CAUTION: If you claim this credit even though you're not eligible and it's determined that your error is due to reckless or intentional disregard of the rules, but not fraud, you won't be allowed to claim the credit for 2 years. If it's determined that your error is due to fraud, you won't be allowed to claim the credit for 10 years.

Can You Claim the Credit?

The following rules will help you determine if you are eligible to claim the American opportunity credit on your tax return.

Who Can Claim the Credit?

Generally, you can claim the American opportunity credit if all three of the following requirements are met.

Student qualifications. Generally, you can claim the American opportunity credit for a student only if all of the following four requirements are met.

Example 1. Sharon was never eligible for the Hope scholarship credit (available before 2009) but was eligible for the American opportunity credit for 2010, 2011, 2013, and 2015. Her parents claimed the American opportunity credit for Sharon on their 2010, 2011, and 2013 tax returns. Sharon claimed the American opportunity credit on her 2015 tax return. The American opportunity credit and Hope scholarship credit have been claimed for Sharon for 4 tax years before 2016. Therefore, the American opportunity credit can't be claimed for Sharon for 2016. If Sharon were to file Form 8863 for 2016, she would check "Yes" for Part III, line 23, and would be eligible to claim only the lifetime learning credit.

Example 2. Wilbert was eligible for the American opportunity credit for 2012, 2013, 2014, and 2016. His parents claimed the American opportunity credit for Wilbert on their tax returns for 2012, 2013, and 2014. No one claimed an American opportunity credit or Hope scholarship credit for Wilbert for any other tax year. The American opportunity credit and Hope scholarship credit have been claimed for Wilbert for only 3 tax years before 2016. Therefore, Wilbert meets the second requirement to be eligible for the American opportunity credit. If Wilbert were to file Form 8863 for 2016, he would check "No" for Part III, line 23. If Wilbert meets all of the other requirements, he is eligible for the American opportunity credit.

Example 3. Glenda enrolls on a full-time basis in a degree program for the 2017 spring semester, which begins in January 2017. Glenda pays her tuition for the 2017 spring semester in December 2016. Because the tuition Glenda paid in 2016 relates to an academic period that begins in the first 3 months of 2017, her eligibility to claim an American opportunity credit in 2016 is determined as if the 2017 spring semester began in 2016. Therefore, Glenda satisfies this third requirement.

TIP: If the requirements above aren't met for any student, you can't claim the American opportunity credit for that student. You may be able to claim the lifetime learning credit for part or all of that student's qualified education expenses instead.

"Qualified education expenses" are defined later under Qualified Education Expenses. "Eligible students" are defined later under Who Is an Eligible Student. A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's Expenses.

You may find Figure 2-1 helpful in determining if you can claim an American opportunity credit on your tax return.

You can't claim the American opportunity credit for 2016 if any of the following apply.

The American opportunity credit is based on adjusted qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, the credit is allowed for adjusted qualified education expenses paid in 2016 for an academic period beginning in 2016 or beginning in the first 3 months of 2017.

For example, if you paid $1,500 in December 2016 for qualified tuition for the spring 2017 semester beginning January 2017, you can use that $1,500 in figuring your 2016 credit.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.

Paid with borrowed funds. You can claim an American opportunity credit for qualified education expenses paid with the proceeds of a loan. Use the expenses to figure the American opportunity credit for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan payments sent directly to the educational institution as paid on the date the institution credits the student's account.

Student withdraws from class(es). You can claim an American opportunity credit for qualified education expenses not refunded when a student withdraws.

Qualified Education Expenses

For purposes of the American opportunity credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.

Eligible educational institution. An eligible educational institution is generally any accredited public, nonprofit, or proprietary (privately owned profit-making) college, university, vocational school, or other postsecondary educational institution. Also, the institution must be eligible to participate in a student aid program administered by the U.S. Department of Education. Virtually all accredited postsecondary institutions meet this definition.

An eligible educational institution also includes certain educational institutions located outside the United States that are eligible to participate in a student aid program administered by the U.S. Department of Education.

TIP: The educational institution should be able to tell you if it is an eligible educational institution.

Related expenses. Student activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance.

However, expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution.

Prepaid expenses. Qualified education expenses paid in 2016 for an academic period that begins in the first 3 months of 2017 can be used in figuring an education credit for 2016 only. See Academic period, earlier. For example, if you pay $2,000 in December 2016 for qualified tuition for the 2017 winter quarter that begins in January 2017, you can use that $2,000 in figuring an education credit for 2016 only (if you meet all the other requirements).

CAUTION: You can't use any amount you paid in 2015 or 2017 to figure the qualified education expenses you use to figure your 2016 education credit(s).

In the following examples, assume that each student is an eligible student at an eligible educational institution.

Example 1. Jefferson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Because the equipment rental is needed for his course of study, Jefferson's equipment rental fee is a qualified expense.

Example 2. Grace and William, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. William bought his books from a friend; Grace bought hers at College W's bookstore. Both are qualified education expenses for the American opportunity credit.

Example 3. When Kelly enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and the student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Kelly's enrollment and attendance at College X and is a qualified expense.

No Double Benefit Allowed

You can't do any of the following.

For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. The result is the amount of adjusted qualified education expenses for each student.

Tax-free educational assistance. For tax-free educational assistance received in 2016, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. See Academic period, earlier.

Some tax-free educational assistance received after 2016 may be treated as a refund of qualified education expenses paid in 2016. This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2016 for qualified education expenses paid on behalf of a student in 2016 (or attributable to enrollment at an eligible educational institution during 2016).

If this tax-free educational assistance is received after 2016 but before you file your 2016 income tax return, see Refunds received after 2016 but before your income tax return is filed, later. If this tax-free educational assistance is received after 2016 and after you file your 2016 income tax return, see Refunds received after 2016 and after your income tax return is filed, later.

Tax-free educational assistance includes:

TIP: You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. For examples, see Coordination with Pell grants and other scholarships, later.

Refunds. A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Some tax-free educational assistance received after 2016 may be treated as a refund. See Tax-free educational assistance, earlier.

Refunds received in 2016. For each student, figure the adjusted qualified education expenses for 2016 by adding all the qualified education expenses for 2016 and subtracting any refunds of those expenses received from the eligible educational institution during 2016.

Refunds received after 2016 but before your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid before you file an income tax return for 2016, the amount of qualified education expenses for 2016 is reduced by the amount of the refund.

Refunds received after 2016 and after your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid after you file an income tax return for 2016, you may need to repay some or all of the credit. See Credit recapture next.

Credit recapture. If any tax-free educational assistance for the qualified education expenses paid in 2016, or any refund of your qualified education expenses paid in 2016, is received after you file your 2016 income tax return, you must recapture (repay) any excess credit. You do this by refiguring the amount of your adjusted qualified education expenses for 2016 by reducing the expenses by the amount of the refund or tax-free educational assistance. You then refigure your education credit(s) for 2016 and figure the amount by which your 2016 tax liability would have increased if you claimed the refigured credit(s). Include that amount as an additional tax for the year the refund or tax-free assistance was received.

Example. You paid $7,000 tuition and fees in August 2016, and your child began college in September 2016. You filed your 2016 tax return on February 17, 2017, and claimed an American opportunity credit of $2,500. After you filed your return, you received a refund of $4,000. You must refigure your 2016 American opportunity credit using $3,000 of qualified education expenses instead of $7,000. The refigured credit is $2,250. The increase to your tax liability is $250. Include the difference of $250 as additional tax on your 2017 tax return. See the instructions for your 2017 income tax return to determine where to include this tax.

TIP: If you pay qualified education expenses in both 2016 and 2017 for an academic period that begins in the first 3 months of 2017 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified education expenses for 2017 instead of reducing your expenses for 2016.

Amounts that don't reduce qualified education expenses. Don't reduce qualified education expenses by amounts paid with funds the student receives as:

University X applies the $2,000 scholarship against Joan's $8,000 total bill, and Joan pays the $6,000 balance of her bill from University X with a combination of her student loan and her savings. Joan doesn't report any portion of the scholarship as income on her tax return.

In figuring the amount of either education credit (American opportunity or lifetime learning), Joan must reduce her qualified education expenses by the amount of the scholarship ($2,000) because she excluded the entire scholarship from her income. The student loan isn't tax-free educational assistance, so she doesn't need to reduce her qualified expenses by any part of the loan proceeds. Joan is treated as having paid $1,000 in qualified education expenses ($3,000 tuition - $2,000 scholarship).

Example 2. The facts are the same as in Example 1, except that Joan reports her entire scholarship as income on her tax return. Because Joan reported the entire $2,000 scholarship in her income, she doesn't need to reduce her qualified education expenses. Joan is treated as having paid $3,000 in qualified education expenses.

Coordination with Pell grants and other scholarships. You may be able to increase your American opportunity credit when the student (you, your spouse, or your dependent) includes certain scholarships or fellowship grants in the student's gross income. Your credit may increase only if the amount of the student's qualified education expenses minus the total amount of scholarships and fellowship grants is less than $4,000. If this situation applies, consider including some or all of the scholarship or fellowship grant in the student's income in order to treat the included amount as paying nonqualified expenses instead of qualified education expenses. Nonqualified expenses are expenses such as room and board that aren't qualified education expenses such as tuition and related fees.

Scholarships and fellowship grants that the student includes in income don't reduce the student's qualified education expenses available to figure your American opportunity credit. Thus, including enough scholarship or fellowship grant in the student's income to report up to $4,000 in qualified education expenses for your American opportunity credit may increase the credit by enough to increase your tax refund or reduce the amount of tax you owe even considering any increased tax liability from the additional income. However, the increase in tax liability as well as the loss of other tax credits may be greater than the additional American opportunity credit and may cause your tax refund to decrease or the amount of tax you owe to increase. Your specific circumstances will determine what amount, if any, of scholarship or fellowship grant to include in income to maximize your tax refund or minimize the amount of tax you owe.

The scholarship or fellowship grant must be one that may qualify as a tax-free scholarship under the rules discussed in chapter 1. Also, the scholarship or fellowship grant must be one that may (by its terms) be used for non-qualified expenses. Finally, the amount of the scholarship or fellowship grant that is applied to non-qualified expenses can't exceed the amount of the student's actual non-qualified expenses that are paid in the tax year. This amount may differ from the student's living expenses estimated by the student's school in figuring the official cost of attendance under student aid rules.

The fact that the educational institution applies the scholarship or fellowship grant to qualified education expenses, such as tuition and related fees, doesn't prevent the student from choosing to apply certain scholarships or fellowship grants to the student's actual nonqualified expenses. By making this choice (that is, by including the part of the scholarship or fellowship grant applied to the student's nonqualified expenses in income), the student may increase taxable income and may be required to file a tax return. But, this allows payments made in cash, by check, by credit or debit card, or with borrowed funds such as a student loan to be applied to qualified education expenses.

Example 1--No scholarship. Bill Pass, age 28 and unmarried, enrolled full-time in 2016 as a first-year student at a local college to earn a degree in law enforcement. This was his first year of postsecondary education. During 2016, he paid $5,600 for his qualified education expenses and $4,400 for his room and board for the fall 2016 semester. He and the college meet all the requirements for the American opportunity credit. Bill's adjusted gross income (AGI) and his MAGI, for purposes of figuring his credit, are $30,400. Bill claims the standard deduction of $6,300 and personal exemption of $4,050, resulting in taxable income of $20,050 and an income tax liability before credits of $2,548. Bill claims no credits other than the American opportunity credit. He figures his American opportunity credit based on qualified education expenses of $4,000, which results in a credit of $2,500 and a tax liability after credits of $48 ($2,548 - $2,500).

Example 2--Scholarship excluded from income. The facts are the same as in Example 1--No scholarship, except that Bill was awarded a $5,600 scholarship. Under the terms of his scholarship, it may be used to pay any educational expenses, including room and board. If Bill excludes the scholarship from income, he will be deemed (for purposes of figuring his education credit) to have applied the scholarship to pay his tuition, required fees, and course materials. His adjusted qualified education expenses would be zero and he wouldn't have an education credit. Therefore, Bill's tax liability after credits would be $2,548.

Example 3--Scholarship partially included in income. The facts are the same as in Example 2--Scholarship excluded from income. If, unlike Example 2, Bill includes $4,000 of the scholarship in income, he will be deemed to have applied that amount to pay for room and board. The remaining $1,600 of the $5,600 scholarship would reduce his qualified education expenses and his adjusted qualified education expenses would be $4,000. Bill's AGI and MAGI would increase to $34,400, his taxable income would increase to $24,050, and his tax liability before credits would increase to $3,148. Based on his adjusted qualified education expenses of $4,000, Bill would be able to claim an American opportunity credit of $2,500 and his tax liability after credits would be $648.

Example 4--Scholarship applied by the postsecondary school to tuition. The facts are the same as in Example 3--Scholarship partially included in income, except the $5,600 scholarship is paid directly to the local college. The fact that the local college applies the scholarship to Bill's tuition and related fees doesn't prevent Bill from including $4,000 of the scholarship in income. As in Example 3, by doing so, he will be deemed to have applied $4,000 to pay for room and board. Bill would be able to claim the American opportunity credit of $2,500 and his tax liability after credits would be $648.

Example 5--Student with a dependent child. Jane Doe, age 28 and unmarried, enrolled full-time as a first-year student at a local technical college to get a certificate as a computer technician. This was her first year of postsecondary education. During 2016, she paid $6,000 for qualified education expenses. She and the college meet all the requirements for the American opportunity credit. Jane has a dependent child, age 10, who is a qualifying child for purposes of receiving the earned income credit (EIC) and the child tax credit. Jane's wages are $20,000. Jane withheld no income taxes on these wages and has no other income or adjustments. Jane was awarded a $5,500 scholarship. Under the terms of her scholarship, it may be used to pay tuition and any living expense, including rent. Jane paid $10,000 in living expenses in 2016.

If Jane excludes the entire scholarship from income, she will be deemed to have applied the entire scholarship to pay qualified education expenses. Her AGI and MAGI would be $20,000. Her tax liability before any credits would be $261. Her qualified education expenses would be reduced to $500. She would be able to receive a $461 American opportunity credit ($200 refundable and $261 nonrefundable), a $1,000 additional child tax credit, and a $3,080 earned income credit. In total, she would be able to receive a tax refund of $4,280.

If Jane includes the entire scholarship in income, she will be deemed to have applied the entire scholarship to pay living expenses. Her qualified education expenses would be $6,000, and her AGI and MAGI would be $25,500. Her tax liability before any credits would be $813. She would be able to receive a $1,813 American opportunity credit ($1,000 refundable and $813 nonrefundable), a $1,000 additional child tax credit, and a $2,201 earned income credit. In total, she would be able to receive a tax refund of $4,201.

If Jane includes $3,500 of the scholarship in income, she will be deemed to have applied $3,500 of the scholarship to pay living expenses, and $2,000 to pay qualified education expenses. Her qualified education expenses would be $4,000, and her AGI and MAGI would be $23,500. Her tax liability before any credits would be $613. She would be able to receive a $1,613 American opportunity credit ($1,000 refundable and $613 nonrefundable), a $1,000 additional child tax credit, and a $2,520 earned income credit. In total, she would be able to receive a tax refund of $4,520.

If Jane includes $1,500 of the scholarship in income, she will be deemed to have applied $1,500 of the scholarship to pay living expenses, and $4,000 to pay qualified education expenses. Her qualified education expenses would be $2,000, and her AGI and MAGI would be $21,500. Her tax liability before any credits would be $413. She would be able to receive a $1,213 American opportunity credit ($800 refundable and $413 nonrefundable), a $1,000 additional child tax credit, and a $2,840 earned income credit. In total, she would be able to receive a tax refund of $4,640. This is the highest tax refund among these scenarios.

Note. Whether you will benefit from applying a scholarship or fellowship grant to nonqualified expenses will depend on the amount of the student's qualified education expenses, the amount of the scholarship or fellowship grant, and whether the scholarship or fellowship grant may (by its terms) be used for nonqualified expenses. Any benefit will also depend on the student's federal and state marginal tax rates as well as any federal and state tax credits the student claims. Before deciding, look at the total amount of your federal and state tax refunds or taxes owed and, if the student is your dependent, the student's tax refunds or taxes owed. For example, if you are the student and you also claim the earned income credit, choosing to apply a scholarship or fellowship grant to nonqualified expenses by including the amount in your income may benefit you if the increase to your American opportunity credit is more than the decrease to your earned income credit. Many students who have no children and who are eligible to claim the earned income credit will maximize the benefit of claiming both the American opportunity credit and the earned income credit if they have $4,000 in qualified tuition and related expenses, even if this means income from the scholarship or fellowship grant reduces the amount of the earned income credit they are eligible to claim. In the case of students who have a qualifying child and who claim the earned income credit with respect to that child, many can maximize the benefit of claiming both the American opportunity credit and the earned income credit if they have at least $2,000 in qualified tuition and related expenses, even if this means income from the scholarship or fellowship grant reduces the amount of the earned income credit they are eligible to claim.

Expenses That Don't Qualify

Qualified education expenses don't include amounts paid for:

Sports, games, hobbies, and noncredit courses. Qualified education expenses generally don't include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify.

Comprehensive or bundled fees. Some eligible educational institutions combine all of their fees for an academic period into one amount. If you don't receive or don't have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed earlier, contact the institution. The institution is generally required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T, Tuition Statement. See Figuring the Credit, later, for more information about Form 1098-T.

Who Is an Eligible Student?

To claim the American opportunity credit, the student for whom you pay qualified education expenses must be an eligible student. This is a student who meets all of the following requirements.

Exception. Any academic credit awarded solely on the basis of the student's performance on proficiency examinations is disregarded in determining whether the student has completed 4 years of postsecondary education.

Enrolled at least half-time. A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.

The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than any of those established by the U.S. Department of Education under the Higher Education Act of 1965.

Example 1. Mack graduated from high school in June 2015. In September, he enrolled in an undergraduate degree program at College U, and attended full-time for both the 2015 fall and 2016 spring semesters. For the 2016 fall semester, Mack was enrolled less than half-time. Because Mack was enrolled in an undergraduate degree program on at least a half-time basis for at least one academic period that began during 2015 and at least one academic period that began during 2016, he is an eligible student for tax years 2015 and 2016 (including the 2016 fall semester when he enrolled at College U on less than a half-time basis).

Example 2. After taking classes at College V on a part-time basis for a few years, Shelly became a full-time student for the 2016 spring semester. College V classified Shelly as a second-semester senior (fourth year) for the 2016 spring semester and as a first-semester graduate student (fifth year) for the 2016 fall semester. Because College V didn't classify Shelly as having completed the first 4 years of postsecondary education as of the beginning of 2016, Shelly is an eligible student for tax year 2016. Therefore, the qualified education expenses paid for the 2016 spring semester and the 2016 fall semester are taken into account in figuring the American opportunity credit for 2016.

Example 3. During the 2016 fall semester, Larry was a high school student who took classes on a half-time basis at College X. Larry wasn't enrolled as part of a degree program at College X because College X only admits students to a degree program if they have a high school diploma or equivalent. Because Larry wasn't enrolled in a degree program at College X during 2016, Larry wasn't an eligible student for tax year 2016.

Example 4. The facts are the same as in Example 3. During the 2016 spring semester, Larry again attended College X but not as part of a degree program. Larry graduated from high school in June 2016. For the 2016 fall semester, Larry enrolled as a full-time student in College X as part of a degree program, and College X awarded Larry credit for his prior coursework at College X. Because Larry was enrolled in a degree program at College X for the 2016 fall term on at least a half-time basis, Larry is an eligible student for all of tax year 2016. Therefore, the qualified education expenses paid for classes taken at College X during both the 2016 spring semester (during which Larry wasn't enrolled in a degree program) and the 2016 fall semester are taken into account in figuring any American opportunity credit.

Example 5. Dee graduated from high school in June 2015. In January 2016, Dee enrolled in a 1-year postsecondary certificate program on a full-time basis to obtain a certificate as a travel agent. Dee completed the program in December 2016, and was awarded a certificate. In January 2017, she enrolled in a 1-year postsecondary certificate program on a full-time basis to obtain a certificate as a computer programmer. Dee is an eligible student for both tax years 2016 and 2017 because she meets the degree requirement, the work load requirement, and the year of study requirement for those years.

Who Can Claim a Dependent's Expenses?

If there are qualified education expenses for your dependent during a tax year, either you or your dependent, but not both of you, can claim an American opportunity credit for your dependent's expenses for that year.

For you to claim an American opportunity credit for your dependent's expenses, you must also claim an exemption for your dependent. You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c.

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TIP: Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent.

Expenses paid by you. If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the American opportunity credit. If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the American opportunity credit.

Expenses paid by others. Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. If you claim an exemption on your tax return for the student, you are considered to have paid the expenses.

Example. In 2016, Ms. Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. For purposes of claiming an American opportunity credit, Todd is treated as receiving the money from his grandmother and, in turn, paying his qualified education expenses himself.

Unless an exemption for Todd is claimed on someone else's 2016 tax return, only Todd can use the payment to claim an American opportunity credit.

If anyone, such as Todd's parents, claims an exemption for Todd on his or her 2016 tax return, whoever claims the exemption may be able to use the expenses to claim an American opportunity credit. If anyone else claims an exemption for Todd, Todd can't claim an American opportunity credit.

Tuition reduction. When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1.

Figuring the Credit

The amount of the American opportunity credit (per eligible student) is the sum of:

Example. Jack and Kay Ford are married and file a joint tax return. For 2016, they claim an exemption for their dependent daughter on their tax return. Their MAGI is $70,000. Their daughter is in her junior (third) year of studies at the local university. Jack and Kay paid qualified education expenses of $4,300 in 2016.

Jack and Kay, their daughter, and the local university meet all of the requirements for the American opportunity credit. Jack and Kay can claim a $2,500 American opportunity credit in 2016. This is 100% of the first $2,000 of qualified education expenses, plus 25% of the next $2,000.

Form 1098-T. To help you figure your American opportunity credit, the student may receive Form 1098-T, Tuition Statement. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2017. An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. However, the amounts on Form 1098-T, boxes 1 and 2, might be different than what you paid. When figuring the credit, use only the amounts you paid or are deemed to have paid in 2016 for qualified education expenses.

In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student.

The eligible educational institution may ask for a completed Form W-9S, Request for Student's or Borrower's Taxpayer Identification Number and Certification, or similar statement to obtain the student's name, address, and taxpayer identification number.

Effect of the Amount of Your Income on the Amount of Your Credit

The amount of your American opportunity credit is phased out (gradually reduced) if your MAGI is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return). You can't claim an American opportunity credit if your MAGI is $90,000 or more ($180,000 or more if you file a joint return).

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form.

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any:

Worksheet 2-1. MAGI for the American Opportunity Credit

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Example. You are filing a joint return and your MAGI is $165,000. In 2016, you paid $5,000 of qualified education expenses.

You figure a tentative American opportunity credit of $2,500 (100% of the first $2,000 of qualified education expenses, plus 25% of the next $2,000 of qualified education expenses).

Because your MAGI is within the range of incomes where the credit must be reduced, you must multiply your tentative credit ($2,500) by a fraction. The numerator (top part) of the fraction is $180,000 (the upper limit for those filing a joint return) minus your MAGI. The denominator (bottom part) is $20,000, the range of incomes for the phaseout ($160,000 to $180,000). The result is the amount of your phased out (reduced) American opportunity credit ($1,875).

                  $180,000 - $165,000

You don't qualify for a refund if items 1 (a, b, or c), 2, and 3 below apply to you.

If you are a sole proprietor or a partner in a trade or business in which both personal services and capital are material income-producing factors, earned income also includes a reasonable allowance for compensation for personal services, but not more than 30% of your share of the net profits from that trade or business (after subtracting the deduction for one-half of self-employment tax). However, if capital isn't an income-producing factor and your personal services produced the business income, the 30% limit doesn't apply.

Support. Your support includes food, shelter, clothing, medical and dental care, education, and the like. Generally, the amount of the item of support will be the amount of expenses incurred by the one furnishing such item. If the item of support is in the form of property or lodging, measure the amount of such item of support by its fair market value. However, a scholarship received by you isn't considered support if you are a full-time student. See Pub. 501 for details.

Full-time student. You are a full-time student for 2016 if during any part of any 5 calendar months during the year you were enrolled as a full-time student at an eligible educational institution (defined earlier), or took a full-time, on-farm training course given by such an institution or by a state, county, or local government agency.

Claiming the Credit

You claim the American opportunity credit by completing Form 1040 or 1040A. Enter the nonrefundable part of the credit on Form 1040, line 50, or on Form 1040A, line 33. Enter the refundable part of the credit on Form 1040, line 68, or on Form 1040A, line 44. A filled-in Form 8863 is shown at the end of this publication.

Note. In Appendix A at the end of this publication, there is an example illustrating the use of Form 8863 when both the American opportunity credit and the lifetime learning credit are claimed on the same tax return.

3. Lifetime Learning Credit

Introduction

For 2016, there are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. They are the American opportunity credit and the lifetime learning credit. This chapter discusses the lifetime learning credit. The American opportunity credit is discussed in chapter 2.

This chapter explains:

A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. The lifetime learning credit is a nonrefundable credit. This means that it can reduce your tax to zero, but if the credit is more than your tax the excess won't be refunded to you.

Your allowable lifetime learning credit may be limited by the amount of your income and the amount of your tax.

Can you claim more than one education credit this year? For each student, you can elect for any year only one of the credits. For example, if you elect to claim the lifetime learning credit for a child on your 2016 tax return, you can't, for that same child, also claim the American opportunity credit for 2016.

If you are eligible to claim the lifetime learning credit and you are also eligible to claim the American opportunity credit for the same student in the same year, you can choose to claim either credit, but not both.

TIP: If you claim the American opportunity credit for any student, you can choose between using that student's adjusted qualified education expenses for the American opportunity credit or the lifetime learning credit. If you have the choice, the American opportunity credit will always be greater than the lifetime learning credit.

If you pay qualified education expenses for more than one student in the same year, you can choose to claim certain credits on a per-student, per-year basis. This means that, for example, you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year.

Differences between the American opportunity and lifetime learning credits. There are several differences between these two credits. For example, you can claim the American opportunity credit for the same student for no more than 4 tax years, but any year in which the Hope scholarship credit was claimed counts toward the 4 years. However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. The differences between these credits are shown in Appendix B near the end of this publication.

Overview of the lifetime learning credit for 2016. See Table 3-1 for the basics of the credit. The details are discussed in this chapter.

Table 3-1. Overview of the Lifetime Learning Credit for 2016

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Who Can Claim the Credit?

Generally, you can claim the lifetime learning credit if all three of the following requirements are met.

"Qualified education expenses" are defined later under Qualified Education Expenses. "Eligible students" are defined later under Who Is an Eligible Student. A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's Expenses.

You may find Figure 3-1 helpful in determining if you can claim a lifetime learning credit on your tax return.

You can't claim the lifetime learning credit for 2016 if any of the following apply.

The lifetime learning credit is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, the credit is allowed for qualified education expenses paid in 2016 for an academic period beginning in 2016 or in the first 3 months of 2017.

For example, if you paid $1,500 in December 2016 for qualified tuition for the spring 2017 semester beginning in January 2017, you may be able to use that $1,500 in figuring your 2016 credit.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.

Paid with borrowed funds. You can claim a lifetime learning credit for qualified education expenses paid with the proceeds of a loan. You use the expenses to figure the lifetime learning credit for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan disbursements sent directly to the educational institution as paid on the date the institution credits the student's account.

Student withdraws from class(es). You can claim a lifetime learning credit for qualified education expenses not refunded when a student withdraws.

Qualified Education Expenses

For purposes of the lifetime learning credit, qualified education expenses are tuition and certain related expenses required for enrollment in a course at an eligible educational institution. The course must be either part of a postsecondary degree program or taken by the student to acquire or improve job skills.

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.

Related expenses. Student activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution for enrollment or attendance.

Prepaid expenses. Qualified education expenses paid in 2016 for an academic period that begins in the first 3 months of 2017 can be used in figuring an education credit for 2016 only. See Academic period, earlier. For example, if you pay $2,000 in December 2016 for qualified tuition for the 2017 winter quarter that begins in January 2017, you can use that $2,000 in figuring an education credit for 2016 only (if you meet all the other requirements).

CAUTION: You can't use any amount you paid in 2015 or 2017 to figure the qualified education expenses you use to figure your 2016 education credit(s).

In the following examples, assume that each student is an eligible student at an eligible educational institution.

Example 1. Jackson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified expense.

Example 2. Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. Charles bought his books from a friend, so what he paid for them isn't a qualified education expense. Donna bought hers at College W's bookstore. Although Donna paid College W directly for her first-year books and materials, her payment isn't a qualified expense because the books and materials aren't required to be purchased from College W for enrollment or attendance at the institution.

Example 3. When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. Therefore, it is a qualified expense.

No Double Benefit Allowed

You can't do any of the following.

For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. The result is the amount of adjusted qualified education expenses for each student.

Tax-free educational assistance. For tax-free educational assistance received in 2016, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. See Academic period, earlier.

Some tax-free educational assistance received after 2016 may be treated as a refund of qualified education expenses paid in 2016. This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2016 for qualified education expenses paid on behalf of a student in 2016 (or attributable to enrollment at an eligible educational institution during 2016).

If this tax-free educational assistance is received after 2016 but before you file your 2016 income tax return, see Refunds received after 2016 but before your income tax return is filed, later. If this tax-free educational assistance is received after 2016 and after you file your 2016 income tax return, see Refunds received after 2016 and after your income tax return is filed, later.

Tax-free educational assistance includes:

TIP: You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. For examples, see Coordination with Pell grants and other scholarships, later.

Refunds. A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Some tax-free educational assistance received after 2016 may be treated as a refund. See Tax-free educational assistance, earlier.

Refunds received in 2016. For each student, figure the adjusted qualified education expenses for 2016 by adding all the qualified education expenses for 2016 and subtracting any refunds of those expenses received from the eligible educational institution during 2016.

Refunds received after 2016 but before your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid before you file an income tax return for 2016, the amount of qualified education expenses for 2016 is reduced by the amount of the refund.

Refunds received after 2016 and after your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid after you file an income tax return for 2016, you may need to repay some or all of the credit. See Credit recapture next.

Credit recapture. If any tax-free educational assistance for the qualified education expenses paid in 2016 or any refund of your qualified education expenses paid in 2016 is received after you file your 2016 income tax return, you must recapture (repay) any excess credit. You do this by refiguring the amount of your adjusted qualified education expenses for 2016 by reducing the expenses by the amount of the refund or tax-free educational assistance. You then refigure your education credit(s) for 2016 and figure the amount by which your 2016 tax liability would have increased if you had claimed the refigured credit(s). Include that amount as an additional tax for the year the refund or tax-free assistance was received.

Example. You pay $9,300 in tuition and fees in December 2016, and your child began college in January 2017. You filed your 2016 tax return on February 14, 2017, and claimed a lifetime learning credit of $1,860. You claimed no other tax credits. After you filed your return, your child withdrew from two courses and you received a refund of $2,900. You must refigure your 2016 lifetime learning credit using $6,400 of qualified education expenses instead of $9,300. The refigured credit is $1,280 and your tax liability increased by $580. See the instructions for your 2017 income tax return to determine where to include this tax.

TIP: If you pay qualified education expenses in both 2016 and 2017 for an academic period that begins in the first 3 months of 2017 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified education expenses for 2017 instead of reducing your expenses for 2016.

Amounts that don't reduce qualified education expenses. Don't reduce qualified education expenses by amounts paid with funds the student receives as:

Coordination with Pell grants and other scholarships. You may be able to increase your lifetime learning credit when the student (you, your spouse, or your dependent) includes certain scholarships or fellowship grants in the student's gross income. Your credit may increase only if the amount of the student's qualified education expenses minus the total amount of scholarships and fellowship grants is less than $10,000. If this situation applies, consider including some or all of the scholarship or fellowship grant in the student's income in order to treat the included amount as paying nonqualified expenses instead of qualified education expenses. Nonqualified expenses are expenses such as room and board that aren't qualified education expenses such as tuition and related fees.

Scholarships and fellowship grants that the student includes in income don't reduce the student's qualified education expenses available to figure your lifetime learning credit. Thus, including enough of the scholarship or fellowship grant in the student's income to report up to $10,000 in qualified education expenses for your lifetime learning credit may increase the credit by enough to increase your tax refund or reduce the amount of tax you owe even considering any increased tax liability from the additional income. However, the increase in tax liability as well as the loss of other tax credits may be greater than the additional lifetime learning credit and may cause your tax refund to decrease or the amount of tax you owe to increase. Your specific circumstances will determine what amount, if any, of the scholarship or fellowship grant to include in income to maximize your tax refund or minimize the amount of tax you owe.

The scholarship or fellowship grant must be one that may qualify as a tax-free scholarship under the rules discussed in chapter 1. Also, the scholarship or fellowship grant must be one that may (by its terms) be used for nonqualified expenses. Finally, the amount of the scholarship or fellowship grant that is applied to nonqualified expenses can't exceed the amount of the student's actual nonqualified expenses that are paid in the tax year. This amount may differ from the student's living expenses estimated by the student's school in figuring the official cost of attendance under student aid rules.

The fact that the educational institution applies the scholarship or fellowship grant to qualified education expenses, such as tuition and related fees, doesn't prevent the student from choosing to apply certain scholarships or fellowship grants to the student's actual nonqualified expenses. By making this choice (that is, by including the part of the scholarship or fellowship grant applied to the student's nonqualified expenses in income), the student may increase taxable income and may be required to file a tax return. But this allows payments made in cash, by check, by credit or debit card, or with borrowed funds such as a student loan to be applied to qualified education expenses.

Example 1--No scholarship. Judy Green, who is unmarried, is taking courses at a public community college to be recertified to teach in public schools. Her adjusted gross income (AGI) and her MAGI, for purposes of the credit, are $27,400. Judy claims the standard deduction of $6,300 and personal exemption of $4,050, resulting in taxable income of $17,050 and a tax liability before credits of $2,098. Judy claims no credits other than the lifetime learning credit. In July 2016, she paid $700 for the summer 2016 semester; in August 2016, she paid $1,900 for the fall 2016 semester; and in December 2016, she paid another $1,900 for the spring semester beginning in January 2017. Judy and the college meet all requirements for the lifetime learning credit. She can use all of the $4,500 tuition she paid in 2016 when figuring her 2016 lifetime learning credit. She claims a $900 lifetime learning credit and her tax liability after credits is $1,198.

Example 2--Scholarship excluded from income. The facts are the same as in Example 1--No scholarship, except that Judy was awarded a $1,500 scholarship. Under the terms of her scholarship, it may be used to pay any educational expenses, including room and board. If Judy excludes the scholarship from income, she will be deemed (for purposes of figuring her education credit) to have applied the scholarship to pay for tuition, required fees, and course materials. Only $3,000 of the $4,500 tuition she paid in 2016 could be used when figuring her 2016 lifetime learning credit. Her lifetime learning credit would be reduced to $600 and her tax liability after credits would be $1,498.

Example 3--Scholarship included in income. The facts are the same as in Example 2--Scholarship excluded from income. If, unlike Example 2, Judy includes the $1,500 scholarship in income, she will be deemed to have applied the entire scholarship to pay for room and board. Judy's AGI and MAGI would increase to $28,900, her taxable income would be $18,550, and her tax liability before credits would be $2,323. She would be able to use the $4,500 of adjusted qualified education expenses to figure her credit. Judy could claim a $900 lifetime learning credit and her tax liability after credits would be $1,423.

Example 4--Scholarship applied by the postsecondary school to tuition. The facts are the same as in Example 3--Scholarship included in income, except the $1,500 scholarship is paid directly to the public community college. The fact that the public community college applies the scholarship to Judy's tuition and related fees doesn't prevent Judy from including the $1,500 scholarship in income. As in Example 3, by doing so, she will be deemed to have applied the entire scholarship to pay for room and board. Judy could claim the $900 lifetime learning credit and her tax liability after credits would be $1,423.

Note. Whether you will benefit from applying a scholarship or fellowship grant to nonqualified expenses will depend on the amount of the student's qualified education expenses, the amount of the scholarship or fellowship grant, and whether the scholarship or fellowship grant may (by its terms) be used for nonqualified expenses. Any benefit will also depend on the student's federal and state marginal tax rates as well as any federal and state tax credits the student claims. Before deciding, look at the total amount of your federal and state tax refunds or taxes owed and, if the student is your dependent, the student's tax refunds or taxes owed. For example, if you are the student and you also claim the earned income credit, choosing to apply a scholarship or fellowship grant to nonqualified expenses by including the amount in your income may not benefit you if the decrease to your earned income credit as a result of including the scholarship or fellowship grant in income is more than the increase to your lifetime learning credit as a result of including this amount in income.

Expenses That Don't Qualify

Qualified education expenses don't include amounts paid for:

Sports, games, hobbies, and noncredit courses. Qualified education expenses generally don't include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program or is taken by the student to acquire or improve job skills, these expenses can qualify.

Comprehensive or bundled fees. Some eligible educational institutions combine all of their fees for an academic period into one amount. If you don't receive or don't have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. The institution is generally required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T. See Figuring the Credit, later, for more information about Form 1098-T.

Who Is an Eligible Student?

For purposes of the lifetime learning credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution (as defined under Qualified Education Expenses, earlier).

Who Can Claim a Dependent's Expenses?

If there are qualified education expenses for your dependent during a tax year, either you or your dependent, but not both of you, can claim a lifetime learning credit for your dependent's expenses for that year.

For you to claim a lifetime learning credit for your dependent's expenses, you must also claim an exemption for your dependent. You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c.

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TIP: Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent.

Expenses paid by you. If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the lifetime learning credit. If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the lifetime learning credit.

Expenses paid by others. Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. If you claim an exemption on your tax return for the student, you are considered to have paid the expenses.

Example. In 2016, Ms. Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. For purposes of claiming a lifetime learning credit, Todd is treated as receiving the money from his grandmother and, in turn, paying his qualified education expenses himself.

Unless an exemption for Todd is claimed on someone else's 2016 tax return, only Todd can use the payment to claim a lifetime learning credit.

If anyone, such as Todd's parents, claims an exemption for Todd on his or her 2016 tax return, whoever claims the exemption may be able to use the expenses to claim a lifetime learning credit. If anyone else claims an exemption for Todd, Todd can't claim a lifetime learning credit.

Tuition reduction. When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1.

Figuring the Credit

The amount of the lifetime learning credit is 20% of the first $10,000 of qualified education expenses you paid for all eligible students. The maximum amount of lifetime learning credit you can claim for 2016 is $2,000 (20% × $10,000). However, that amount may be reduced based on your MAGI. See Effect of the Amount of Your Income on the Amount of Your Credit, later.

Example. Bruce and Toni Harper are married and file a joint tax return. For 2016, their MAGI is $75,000. Toni is attending a local college (an eligible educational institution) to earn credits toward a degree in nursing. She already has a bachelor's degree in history and wants to become a nurse. In August 2016, Toni paid $5,000 of qualified education expenses for her fall 2016 semester. Bruce and Toni can claim a $1,000 (20% × $5,000) lifetime learning credit on their 2016 joint tax return.

Form 1098-T. To help you figure your lifetime learning credit, the student may receive Form 1098-T. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2017. An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. However, the amounts on Form 1098-T, boxes 1 and 2, might be different from what you paid. When figuring the credit, use only the amounts you paid or are deemed to have paid in 2016 for qualified education expenses.

In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student.

The eligible educational institution may ask for a completed Form W-9S or similar statement to obtain the student's name, address, and taxpayer identification number.

Effect of the Amount of Your Income on the Amount of Your Credit

The amount of your lifetime learning credit is phased out (gradually reduced) if your MAGI is between $55,000 and $65,000 ($111,000 and $131,000 if you file a joint return). You can't claim a lifetime learning credit if your MAGI is $65,000 or more ($131,000 or more if you file a joint return).

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form.

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any:

Worksheet 3-1. MAGI for the Lifetime Learning Credit

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Example. You are filing a joint return with a MAGI of $112,000. In 2016, you paid $6,600 of qualified education expenses.

You figure the tentative lifetime learning credit (20% of the first $10,000 of qualified education expenses you paid for all eligible students). The result is a $1,320 (20% x $6,600) tentative credit.

Because your MAGI is within the range of incomes where the credit must be reduced, you must multiply your tentative credit ($1,320) by a fraction. The numerator (top part) of the fraction is $131,000 (the upper limit for those filing a joint return) minus your MAGI. The denominator (bottom part) is $20,000, the range of incomes for the phaseout ($111,000 to $131,000). The result is the amount of your phased out (reduced) lifetime learning credit ($1,254).

               $131,000 - $112,000

Note. In Appendix A at the end of this publication, there is an example illustrating the use of Form 8863 when both the American opportunity credit and the lifetime learning credit are claimed on the same tax return.

4. Student Loan Interest Deduction

Introduction

Generally, personal interest you pay, other than certain mortgage interest, isn't deductible on your tax return. However, if your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return), there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500.

The student loan interest deduction is claimed as an adjustment to income. This means you can claim this deduction even if you don't itemize deductions on Schedule A (Form 1040).

This chapter explains:

 This table summarizes the features of the student loan

Qualified Student Loan

This is a loan you took out solely to pay qualified education expenses (defined later) that were:

Exceptions. For purposes of the student loan interest deduction, the following are exceptions to the general rules for dependents.

Even if not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of the following requirements are met.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.

Eligible student. This is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.

Enrolled at least half-time. A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.

The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than any of those established by the U.S. Department of Education under the Higher Education Act of 1965.

Related person. You can't deduct interest on a loan you get from a related person. Related persons include:

Qualified Education Expenses

For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.

For purposes of the student loan interest deduction, an eligible educational institution also includes an institution conducting an internship or residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers postgraduate training.

An educational institution must meet the above criteria only during the academic period(s) for which the student loan was incurred. The deductibility of interest on the loan isn't affected by the institution's subsequent loss of eligibility.

TIP: The educational institution should be able to tell you if it is an eligible educational institution.

Adjustments to Qualified Education Expenses

You must reduce your qualified education expenses by the total amount paid for them with the following tax-free items.

In addition to simple interest on the loan, if all other requirements are met, the items discussed below can be student loan interest.

Loan origination fee. In general, this is a one-time fee charged by the lender when a loan is made. To be deductible as interest, a loan origination fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee treated as interest accrues over the life of the loan.

Loan origination fees weren't required to be reported on Form 1098-E, Student Loan Interest Statement, for loans made before September 1, 2004. If loan origination fees aren't included in the amount reported on your Form 1098-E, you can use any reasonable method to allocate the loan origination fees over the term of the loan.

Capitalized interest. This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan. Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made.

Interest on revolving lines of credit. This interest, which includes interest on credit card debt, is student loan interest if the borrower uses the line of credit (credit card) only to pay qualified education expenses. See Qualified Education Expenses, earlier.

Interest on refinanced student loans. This includes interest on both:

Allocating Payments Between Interest and Principal

The allocation of payments between interest and principal for tax purposes might not be the same as the allocation shown on the Form 1098-E or other statement you receive from the lender or loan servicer. To make the allocation for tax purposes, a payment generally applies first to stated interest that remains unpaid as of the date the payment is due, second to any loan origination fees allocable to the payment, third to any capitalized interest that remains unpaid as of the date the payment is due, and fourth to the outstanding principal.

Example. In August 2015, Peg took out a $10,000 student loan to pay the tuition for her senior year of college. The lender charged a 3% loan origination fee ($300) that was withheld from the funds Peg received. The interest (5% simple) on this loan accrued while she completed her senior year and for 6 months after she graduated. At the end of that period, the lender determined the amount to be repaid by capitalizing all accrued but unpaid interest ($625 interest accrued from August 2015 through October 2016) and adding it to the outstanding principal balance of the loan. The loan is payable over 60 months, with a payment of $200.51 due on the first of each month, beginning November 2016.

Peg didn't receive a Form 1098-E for 2016 from her lender because the amount of interest she paid didn't require the lender to issue an information return. However, she did receive an account statement from the lender that showed the following 2016 payments on her outstanding loan of $10,625 ($10,000 principal + $625 accrued but unpaid interest).

 Payment Date   Payment   Stated Interest   Principal

For 2017, Peg will continue to allocate $5 of the loan origination fee to the principal portion of each monthly payment she makes and treat that amount as interest for tax purposes. She also will apply the remaining amount of capitalized interest ($625 - $303.13 = $321.87) to the principal payments in the order in which they are made until the balance is zero, and treat those amounts as interest for tax purposes.

Don't Include as Interest

You can't claim a student loan interest deduction for any of the following items.

You can deduct all interest you paid during the year on your student loan, including voluntary payments, until the loan is paid off.

Can You Claim the Deduction?

Generally, you can claim the deduction if all of the following requirements are met.

Example 1. During 2016, Josh paid $600 interest on his qualified student loan. Only he is legally obligated to make the payments. No one claimed an exemption for Josh for 2016. Assuming all other requirements are met, Josh can deduct the $600 of interest he paid on his 2016 1040A.

Example 2. During 2016, Jo paid $1,100 interest on her qualified student loan. Only she is legally obligated to make the payments. Jo's parents claimed an exemption for her on their 2016 tax return. In this case, neither Jo nor her parents may deduct the student loan interest Jo paid in 2016.

Interest paid by others. If you are the person legally obligated to make interest payments and someone else makes a payment of interest on your behalf, you are treated as receiving the payments from the other person and, in turn, paying the interest.

Example 1. Darla obtained a qualified student loan to attend college. After Darla's graduation from college, she worked as an intern for a nonprofit organization. As part of the internship program, the nonprofit organization made an interest payment on behalf of Darla. This payment was treated as additional compensation and reported on her Form W-2, box 1. Assuming all other qualifications are met, Darla can deduct this payment of interest on her tax return.

Example 2. Ethan obtained a qualified student loan to attend college. After graduating from college, the first monthly payment on his loan was due in December. As a gift, Ethan's mother made this payment for him. No one is claiming a dependency exemption for Ethan on his or her tax return. Assuming all other qualifications are met, Ethan can deduct this payment of interest on his tax return.

No Double Benefit Allowed

You can't deduct as interest on a student loan any amount that is an allowable deduction under any other provision of the tax law (for example, home mortgage interest).

Figuring the Deduction

Your student loan interest deduction is generally the smaller of:

Form 1098-E. To help you figure your student loan interest deduction, you should receive Form 1098-E. Generally, an institution (such as a bank or governmental agency) that received interest payments of $600 or more during 2016 on one or more qualified student loans must send Form 1098-E (or acceptable substitute) to each borrower by January 31, 2017.

For qualified student loans taken out before September 1, 2004, the institution is required to include on Form 1098-E only payments of stated interest. Other interest payments, such as certain loan origination fees and capitalized interest, may not appear on the form you receive. However, if you pay qualifying interest that isn't included on Form 1098-E, you can also deduct those amounts. See Allocating Payments Between Interest and Principal, earlier.

The lender may ask for a completed Form W-9S, or similar statement to obtain the borrower's name, address, and taxpayer identification number. The form may also be used by the borrower to certify that the student loan was incurred solely to pay for qualified education expenses.

Effect of the Amount of Your Income on the Amount of Your Deduction

The amount of your student loan interest deduction is phased out (gradually reduced) if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if you file a joint return). You can't claim a student loan interest deduction if your MAGI is $80,000 or more ($160,000 or more if you file a joint return).

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for student loan interest. However, as discussed below, there may be other modifications.

Table 4-2 shows how the amount of your MAGI can affect your student loan interest deduction.

Table 4-2. Effect of MAGI on Student Loan Interest Deduction

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MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form figured without taking into account any amount on line 33 (student loan interest deduction), line 34 (tuition and fees deduction), or line 35 (domestic production activities deduction), and modified by adding back any:

MAGI when using Form 1040NR-EZ. If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form figured without taking into account any amount on line 9 (student loan interest deduction).

Phaseout. If your MAGI is within the range of incomes where the credit must be reduced, you must figure your reduced deduction. To figure the phaseout, multiply your interest deduction (before the phaseout, but not more than $2,500) by a fraction. The numerator (top part) is your MAGI minus $65,000 ($130,000 in the case of a joint return). The denominator (bottom part) is $15,000 ($30,000 in the case of a joint return). Subtract the result from your deduction (before the phaseout) to give you the amount you can deduct.

Example 1. During 2016, you paid $800 interest on a qualified student loan. Your 2016 MAGI is $145,000 and you are filing a joint return. You must reduce your deduction by $400, figured as follows.

          $145,000 - $130,000

Example 2. The facts are the same as in Example 1 except that you paid $2,750 interest. Your maximum deduction for 2016 is $2,500. You must reduce your maximum deduction by $1,250, figured as follows.

            $145,000 - $130,000

Which Worksheet To Use

Generally, you figure the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040, Form 1040A, or Form 1040NR instructions. However, if you are filing Form 2555-EZ, Foreign Earned Income Exclusion; Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa; or you are excluding income from sources within Puerto Rico, you must complete Worksheet 4-1.

Claiming the Deduction

The student loan interest deduction is an adjustment to income. To claim the deduction, enter the allowable amount on line 33 (Form 1040A), line 33 (Form 1040NR), or line 9 (Form 1040NR-EZ).

Worksheet 4-1. Student Loan Interest Deduction Worksheet

 Keep for Your Records

Introduction

Generally, if you are responsible for making loan payments, and the loan is canceled (forgiven), you must include the amount that was forgiven in your gross income for tax purposes. However, if you fulfill certain requirements, two types of student loan assistance may be tax free. The types of assistance discussed in this chapter are:

If your student loan is canceled, you may not have to include any amount in income. This section describes the requirements for tax-free treatment of canceled student loans.

Qualifying Loans

To qualify for tax-free treatment, for the cancellation of your loan, your loan must have been made by a qualified lender to assist you in attending an eligible educational institution and contain a provision that all or part of the debt will be canceled if you work:

Eligible educational institution. This is an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

Qualified lenders. These include the following.

Section 501(c)(3) organization. This is any corporation, community chest, fund, or foundation organized and operated exclusively for one or more of the following purposes.

Refinanced Loan

If you refinanced a student loan with another loan from an eligible educational institution or a tax-exempt organization, that loan may also be considered as made by a qualified lender. The refinanced loan is considered made by a qualified lender if it is made under a program of the refinancing organization that is designed to encourage students to serve in occupations with unmet needs or in areas with unmet needs where the services required of the students are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization.

Student Loan Repayment Assistance

Student loan repayments made to you are tax free if you received them for any of the following.

6. Tuition and Fees Deduction

Introduction

You may be able to deduct qualified education expenses paid during the year for yourself, your spouse, or your dependent(s). You can't claim this deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax return. The qualified expenses must be for higher education, as explained later under Qualified Education Expenses.

What is the tax benefit of the tuition and fees deduction? The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000.

This deduction is claimed as an adjustment to income. This means you can claim this deduction even if you don't itemize deductions on Schedule A (Form 1040). This deduction may be beneficial to you if you don't qualify for the American opportunity or lifetime learning credits.

TIP: You can choose the education benefit that will give you the lowest tax. You may want to compare the tuition and fees deduction to the education credits. See chapter 2 (American opportunity credit) and chapter 3 (lifetime learning credit) for more information on the education credits.

Table 6-1 summarizes the features of the tuition and fees deduction.

Table 6-1. Tuition and Fees Deduction at a Glance

 Don't rely on this table alone. Refer to the text for complete

Who Can Claim the Deduction?

Generally, you can claim the tuition and fees deduction if all three of the following requirements are met.

Who Can't Claim the Deduction?

You can't claim the tuition and fees deduction if any of the following apply.

The tuition and fees deduction is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, the deduction is allowed for qualified education expenses paid in 2016 in connection with enrollment at an institution of higher education during 2016 or for an academic period beginning in 2016 or in the first 3 months of 2017.

For example, if you paid $1,500 in December 2016 for qualified tuition for the spring 2017 semester beginning in January 2017, you may be able to use that $1,500 in figuring your 2016 deduction.

Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.

Paid with borrowed funds. You can claim a tuition and fees deduction for qualified education expenses paid with the proceeds of a loan. Use the expenses to figure the deduction for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan disbursements sent directly to the educational institution as paid on the date the institution credits the student's account.

Student withdraws from class(es). You can claim a tuition and fees deduction for qualified education expenses not refunded when a student withdraws.

Qualified Education Expenses

For purposes of the tuition and fees deduction, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.

An eligible educational institution also includes certain educational institutions located outside the United States that are eligible to participate in a student aid program administered by the U.S. Department of Education.

TIP: The educational institution should be able to tell you if it is an eligible educational institution.

Related expenses. Student activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.

Prepaid expenses. Qualified education expenses paid in 2016 for an academic period that begins in the first 3 months of 2017 can be used in figuring an education credit for 2016 only. See Academic period, earlier. For example, if you pay $2,000 in December 2016 for qualified tuition for the 2017 winter quarter that begins in January 2017, you can use that $2,000 in figuring an education credit for 2016 only (if you meet all the other requirements).

CAUTION: You can't use any amount you paid in 2015 or 2017 to figure the qualified education expenses you use to figure your 2016 education credit(s).

In the following examples, assume that each student is an eligible student and each college or university an eligible educational institution.

Example 1. Jackson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified education expense.

Example 2. Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. Charles bought his books from a friend, so what he paid for them isn't a qualified education expense. Donna bought hers at College W's bookstore. Although Donna paid College W directly for her first-year books and materials, her payment isn't a qualified education expense because the books and materials aren't required to be purchased from College W for enrollment or attendance at the institution.

Example 3. When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and the student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. Therefore, it is a qualified expense.

No Double Benefit Allowed

You can't do any of the following.

For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. The result is the amount of adjusted qualified education expenses for each student. You must also reduce qualified education expenses by the other amounts referred to in No Double Benefit Allowed, earlier.

Tax-free educational assistance. For tax-free educational assistance received in 2016, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. See Academic period, earlier.

Some tax-free educational assistance received after 2016 may be treated as a refund of qualified education expenses paid in 2016. This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2016 for qualified education expenses paid on behalf of a student in 2016 (or attributable to enrollment at an eligible educational institution during 2016).

If this tax-free educational assistance is received after 2016 but before you file your 2016 income tax return, see Refunds received after 2016 but before your income tax return is filed, later. If this tax-free educational assistance is received after 2016 and after you file your 2016 income tax return, see Refunds received after 2016 and after your income tax return is filed, later.

This tax-free educational assistance includes:

Refunds. A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Some tax-free educational assistance received after 2016 may be treated as a refund. See Tax-free educational assistance, earlier.

Refunds received in 2016. For each student, figure the adjusted qualified education expenses for 2016 by adding all the qualified education expenses for 2016 and subtracting any refunds of those expenses received from the eligible educational institution during 2016.

Refunds received after 2016 but before your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid before you file an income tax return for 2016, the amount of qualified education expenses for 2016 is reduced by the amount of the refund.

Refunds received after 2016 and after your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid after you file an income tax return for 2016, you may need to repay some or all of the credit. See Credit recapture, later.

Coordination with education savings bond, Coverdell education savings account, and qualified tuition programs. Reduce your qualified education expenses by any qualified education expenses used to figure the exclusion from gross income of (a) interest received under an education savings bond program, or (b) any distribution from a Coverdell education savings account or qualified tuition program (QTP). For a QTP, this applies only to the amount of tax-free earnings that were distributed, not to the recovery of contributions to the program.

Credit recapture. If any tax-free educational assistance for the qualified education expenses paid in 2016 or any refund of your qualified education expenses paid in 2016 is received after you file your 2016 income tax return, you must recapture (repay) any excess credit. You do this by refiguring the amount of your adjusted qualified education expenses for 2016 by reducing that amount by the amount of the refund or tax-free educational assistance. You then refigure your education credit(s) for 2016 and figure the amount by which your 2016 tax liability would have increased if you had claimed the refigured credit(s). Include that amount as an additional tax for the year the refund or tax-free assistance was received.

Example. You paid $3,500 of qualified education expenses in December 2016, and your child began college in January 2017. You claimed $3,500 as the tuition and fees deduction on your 2016 income tax return. The reduction reduced your taxable income by $3,500. Also, you claimed no tax credits in 2016. Your child withdrew from two classes and you received a refund of $2,000 in 2017 after you filed your 2016 tax return. Refigure your 2016 tuition and fees deduction using $1,500 of qualified education expenses instead of the $3,500. The refigured tuition and fees deduction is $1,500. Don't file an amended 2016 tax return to account for this adjustment. Instead, include the difference of $2,000 (but only to the extent this difference would have increased your 2016 tax) on the "Other income" line of your 2017 Form 1040A for 2017.

Amounts that don't reduce qualified education expenses. Don't reduce qualified education expenses by amounts paid with funds the student receives as:

University X applies the $2,000 scholarship against Jackie's $8,000 total bill, and Jackie pays the $6,000 balance of her bill from University X with a combination of her student loan and her savings. Jackie doesn't report any portion of the scholarship as income on her tax return.

In figuring the tuition and fees deduction, Jackie must reduce her qualified education expenses by the amount of the scholarship ($2,000) because she excluded the entire scholarship from her income. The student loan isn't tax-free educational assistance, so she doesn't need to reduce her qualified expenses by any part of the loan proceeds. Jackie is treated as having paid $1,000 in qualified education expenses ($3,000 tuition - $2,000 scholarship) in 2016.

Example 2. The facts are the same as in Example 1, except that Jackie reports her entire scholarship as income on her tax return. Because Jackie reported the entire $2,000 scholarship in her income, she doesn't need to reduce her qualified education expenses. Jackie is treated as having paid $3,000 in qualified education expenses.

Expenses That Don't Qualify

Qualified education expenses don't include amounts paid for:

Sports, games, hobbies, and noncredit courses. Qualified education expenses generally don't include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify.

Comprehensive or bundled fees. Some eligible educational institutions combine all of their fees for an academic period into one amount. If you don't receive, or don't have access to, an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. The institution is generally required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T. See Figuring the Deduction, later, for more information about Form 1098-T.

Who Is an Eligible Student?

For purposes of the tuition and fees deduction, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution (as defined under Qualified Education Expenses, earlier).

Who Can Claim a Dependent's Expenses?

Generally, in order to claim the tuition and fees deduction for qualified education expenses for a dependent, you must:

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Expenses paid by you. If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring your tuition and fees deduction.

Expenses paid under divorce decree. Qualified education expenses paid directly to an eligible educational institution for a student under a court-approved divorce decree are treated as paid by the student. Only the student would be eligible to take a tuition and fees deduction for that payment, and then only if no one else could claim an exemption for the student.

Expenses paid by others. Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. If you claim, or can claim, an exemption on your tax return for the student, you aren't considered to have paid the expenses and you can't deduct them. If the student isn't a dependent, only the student can deduct payments made directly to the institution for his or her expenses. If the student is your dependent, no one can deduct the payments.

Example. In 2016, Ms. Baker makes a payment directly to an eligible educational institution for her grandson Dan's qualified education expenses. For purposes of deducting tuition and fees, Dan is treated as receiving the money from his grandmother and, in turn, paying his own qualified education expenses.

If an exemption can't be claimed for Dan on anyone else's tax return, only Dan can claim a tuition and fees deduction for his grandmother's payment. If someone else can claim an exemption for Dan, no one will be allowed a deduction for Ms. Baker's payment.

Tuition reduction. When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1.

Figuring the Deduction

The maximum tuition and fees deduction in 2016 is $4,000, $2,000, or $0, depending on the amount of your MAGI. See Effect of the Amount of Your Income on the Amount of Your Deduction, later.

Form 1098-T. To help you figure your tuition and fees deduction, the student may receive Form 1098-T (see Appendix A for a completed example of Form 1098-T). Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2017. An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. However, the amount on Form 1098-T, boxes 1 and 2, might be different than what you paid. When figuring the deduction, use only the amounts you paid in 2016 for qualified education expenses.

In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student.

The eligible educational institution may ask for a completed Form W-9S or similar statement to obtain the student's name, address, and taxpayer identification number.

Effect of the Amount of Your Income on the Amount of Your Deduction

If your MAGI isn't more than $65,000 ($130,000 if you are married filing jointly), your maximum tuition and fees deduction is $4,000. If your MAGI is larger than $65,000 ($130,000 if you are married filing jointly), but isn't more than $80,000 ($160,000 if you are married filing jointly), your maximum deduction is $2,000. No tuition and fees deduction is allowed if your MAGI is larger than $80,000 ($160,000 if you are married filing jointly).

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for tuition and fees. However, as discussed below, there may be other modifications.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form, figured without taking into account any amount on line 19 (tuition and fees deduction).

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form, figured without taking into account any amount on line 34 (tuition and fees deduction), or line 35 (domestic production activities deduction), and modified by adding back any:

You can use Worksheet 6-1 to figure your MAGI.

Table 6-2. Effect of MAGI on Maximum Tuition and Fees Deduction

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Illustrated Example

Tim Pfister, a single taxpayer, enrolled full-time at a local college to earn a degree in engineering. This is the first year of his postsecondary education. During 2016, he paid $3,600 for his qualified 2016 tuition expense. Both he and the college meet all of the requirements for the tuition and fees deduction. Tim's total income (Form 1040, line 22) and MAGI are $26,000. He figures his deduction of $3,600 as shown on Form 8917, later.

Worksheet 6-1. MAGI for the Tuition and Fees Deduction

 Keep for Your Records

Introduction

If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return.

There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. However, total contributions for the beneficiary in any year can't be more than $2,000, no matter how many accounts have been established. See Contributions, later.

TIP: This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses.

What is the tax benefit of the Coverdell ESA? Contributions to a Coverdell ESA aren't deductible, but amounts deposited in the account grow tax free until distributed.

If, for a year, distributions from an account aren't more than a designated beneficiary's qualified education expenses at an eligible educational institution, the beneficiary won't owe tax on the distributions. See Tax-Free Distributions, later.

Table 7-1 summarizes the main features of the Coverdell ESA.

Table 7-1. Coverdell ESA at a Glance

 Don't rely on this table alone. It provides only general highlights.

When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary.

To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created.

The document creating and governing the account must be in writing and must satisfy the following requirements.

Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses.

Designated beneficiary. This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account.

Contributions to a qualified tuition program (QTP). A contribution to a QTP is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA. In the case of a change in beneficiary, this is a qualified expense only if the new beneficiary is a family member of that designated beneficiary. See chapter 8.

Eligible Educational Institution

For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school.

Eligible postsecondary school. This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.

Eligible elementary or secondary school. This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law.

Qualified Higher Education Expenses

These are expenses related to enrollment or attendance at an eligible postsecondary school. As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time.

Qualified Elementary and Secondary Education Expenses

These are expenses related to enrollment or attendance at an eligible elementary or secondary school. As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. There are special rules for computer-related expenses.

Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual's MAGI (defined later under Contribution Limits) for the year is less than $110,000. For individuals filing joint returns, that amount is $220,000.

Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. There is no requirement that an organization's income be below a certain level.

Contributions must meet all of the following requirements.

Contributions can be made, without penalty, to both a Coverdell ESA and a QTP in the same year for the same beneficiary.

Table 7-2 summarizes many of the features of contributing to a Coverdell ESA.

Table 7-2. Coverdell ESA Contributions at a Glance

 Don't rely on this table alone. It provides only general

For example, if you make a contribution to a Coverdell ESA in February 2017, and you designate it as a contribution for 2016, you are considered to have made that contribution on December 31, 2016.

Contribution Limits

There are two yearly limits.

Example. When Maria Luna was born in 2015, three separate Coverdell ESAs were set up for her, one by her parents, one by her grandfather, and one by her aunt. In 2016, the total of all contributions to Maria's three Coverdell ESAs can't be more than $2,000. For example, if her grandfather contributed $2,000 to one of her Coverdell ESAs, no one else could contribute to any of her three accounts. Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. These contributions could be put into any of Maria's Coverdell ESA accounts.

Limit for each contributor. Generally, you can contribute up to $2,000 for each designated beneficiary for 2016. This is the most you can contribute for the benefit of any one beneficiary for the year, regardless of the number of Coverdell ESAs set up for the beneficiary.

Example. The facts are the same as in the previous example except that Maria Luna's older brother, Edgar, also has a Coverdell ESA. If their grandfather contributed $2,000 to Maria's Coverdell ESA in 2016, he could also contribute $2,000 to Edgar's Coverdell ESA.

Reduced limit. Your contribution limit may be reduced. If your MAGI (defined later) is between $95,000 and $110,000 (between $190,000 and $220,000 if filing a joint return), the $2,000 limit for each designated beneficiary is gradually reduced (see Figuring the limit, later). If your MAGI is $110,000 or more ($220,000 or more if filing a joint return), you can't contribute to anyone's Coverdell ESA.

Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return.

MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form.

MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any:

MAGI when using Form 1040NR-EZ. If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form.

If you have any of these adjustments, you can use Worksheet 7-1 to figure your MAGI for Form 1040.

Worksheet 7-1. MAGI for a Coverdell ESA

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Worksheet 7-2. Coverdell ESA Contribution Limit

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Worksheet 7-2. Coverdell ESA Contribution Limit--Illustrated

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However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. You should receive Form 1099-Q, Payments From Qualified Education Programs, from each institution from which excess contributions were distributed. Box 2 of that form will show the amount of earnings on your excess contributions. Code "2" or "3" entered in the blank box below boxes 5 and 6 indicates the year in which the earnings are taxable. See Instructions for Recipient of your Form 1099-Q, on the back of copy B. Enter the amount of earnings on Form 1040 (or Form 1040NR), line 21, for the applicable tax year. For more information, see Taxable Distributions, later.

The excise tax doesn't apply to any rollover contribution.

Note. Contributions made in one year for the preceding tax year are considered to have been made on the last day of the preceding year.

Example. In 2015, Greta's parents and grandparents contributed a total of $2,300 to Greta's Coverdell ESA-- an excess contribution of $300. Because Greta didn't withdraw the excess before June 1, 2016, she had to pay an additional tax of $18 (6% × $300) when she filed her 2015 tax return.

In 2016, excess contributions of $500 were made to Greta's account, however, she withdrew $250 from that account to use for qualified education expenses. Using the steps shown earlier under Additional Tax on Excess Contributions, Greta figures the excess contribution in her account at the end of 2016 as follows.

    (1) $500 excess contributions

Figuring and reporting the additional tax. You figure this excise tax on Form 5329, Part V. Report the additional tax on Form 1040, line 59 (or Form 1040NR, line 57).

Rollovers and Other Transfers

Assets can be rolled over from one Coverdell ESA to another or the designated beneficiary can be changed. The beneficiary's interest can be transferred to a spouse or former spouse because of divorce.

Rollovers

Any amount distributed from a Coverdell ESA isn't taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary's family (including the beneficiary's spouse) who is under age 30. This age limitation doesn't apply if the new beneficiary is a special needs beneficiary.

An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution.

Don't report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. These aren't taxable distributions.

Members of the beneficiary's family. For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary.

CAUTION: You can make only one rollover from a Coverdell ESA to another Coverdell ESA in any 12-month period regardless of the number of Coverdell ESAs you own. However, you can make unlimited transfers from one Coverdell ESA trustee directly to another Coverdell ESA trustee because such transfers aren't considered to be distributions or rollovers. The limit of one rollover during any 12-month period doesn't apply to the rollover of a military death gratuity or Servicemembers' Group Life Insurance (SGLI) payment.

Military death gratuity. If you received a military death gratuity or a payment from Servicemembers' Group Life Insurance (SGLI), you may roll over all or part of the amount received to one or more Coverdell ESAs for the benefit of members of the beneficiary's family (see Members of the beneficiary's family, earlier). Such payments are made to an eligible survivor upon the death of a member of the U.S. Armed Forces. The contribution to a Coverdell ESA from survivor benefits received can't be made later than 1 year after the date on which you receive the gratuity or SGLI payment.

This rollover contribution isn't subject to (but is in addition to) the contribution limits discussed earlier under Contribution Limits. The amount you roll over can't exceed the total survivor benefits you received, reduced by contributions from these benefits to a Roth IRA or other Coverdell ESAs.

The amount contributed from the survivor benefits is treated as part of your basis (cost) in the Coverdell ESA, and won't be taxed when distributed. See Distributions, later.

CAUTION: The limit of one rollover during any 12-month period doesn't apply to the rollover of a military death gratuity or SGLI payment.

Changing the Designated Beneficiary

The designated beneficiary can be changed. See Members of the beneficiary's family, earlier. There aren't any tax consequences if, at the time of the change, the new beneficiary is under age 30 or is a special needs beneficiary.

Example. Assume the same situation for Aaron as in the last example (see Rollovers, earlier). Instead of closing his Coverdell ESA and paying the distribution into his sister's Coverdell ESA, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his sister.

Transfer Because of Divorce

If a spouse or former spouse receives a Coverdell ESA under a divorce or separation instrument, it isn't a taxable transfer. After the transfer, the spouse or former spouse treats the Coverdell ESA as his or her own.

Example. In their divorce settlement, Peg received her ex-husband's Coverdell ESA. In this process, the account was transferred into her name. Peg now treats the funds in this Coverdell ESA as if she were the original owner.

Distributions

The designated beneficiary of a Coverdell ESA can take a distribution at any time. Whether the distributions are tax free depends, in part, on whether the distributions are equal to or less than the amount of Adjusted qualified education expenses (defined later) the beneficiary has in the same tax year.

See Table 7-3 for highlights.

Table 7-3. Coverdell ESA Distributions at a Glance

 Don't rely on this table alone. It provides only general

Tax-Free Distributions

Generally, distributions are tax free if they aren't more than the beneficiary's adjusted qualified education expenses for the year. Don't report tax-free distributions (including qualifying rollovers) on your tax return.

Taxable Distributions

A portion of the distributions is generally taxable to the beneficiary if the total distributions are more than the beneficiary's adjusted qualified education expenses for the year.

Excess distribution. This is the part of the total distribution that is more than the beneficiary's adjusted qualified education expenses for the year.

Earnings and basis. You will receive a Form 1099-Q for each of the Coverdell ESAs from which money was distributed in 2016. The amount of your gross distribution will be shown in box 1. For 2016, instead of dividing the gross distribution between your earnings (box 2) and your basis (amount already taxed) (box 3), the payer or trustee may report the fair market value (account balance) of the Coverdell ESA as of December 31, 2016. This will be shown in the blank box below boxes 5 and 6.

The amount contributed from survivor benefits (see Military death gratuity, earlier) is treated as part of your basis and won't be taxed when distributed.

Figuring the Taxable Portion of a Distribution

The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account. Figure the taxable portion for 2016 as shown in the following steps.

Example. You received an $850 distribution from your Coverdell ESA, to which $1,500 had been contributed before 2016. There were no contributions in 2016. This is your first distribution from the account, so your basis in the account on December 31, 2015, was $1,500. The value (balance) of your account on December 31, 2016, was $950. You had $700 of adjusted qualified education expenses (AQEE) for the year. Using the steps in Figuring the Taxable Portion of a Distribution, earlier, figure the taxable portion of your distribution as follows.

                            $1,500 basis + $0 contributions

Worksheet 7-3, at the end of this chapter, can help you figure your adjusted qualified education expenses, how much of your distribution must be included in income, and the remaining basis in your Coverdell ESA(s).

Coordination With American Opportunity and Lifetime Learning Credits

The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses aren't used for both benefits. This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American opportunity or lifetime learning credit.

Example. Derek Green had $5,800 of qualified higher education expenses for 2016, his first year in college. He paid his college expenses from the following sources.

 Partial tuition scholarship (tax free)      $1,500

Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses.

 Total qualified higher education expenses      $5,800

    $1,000                 $2,100 basis + $400 contributions

Coordination With Qualified Tuition Program (QTP) Distributions

If a designated beneficiary receives distributions from both a Coverdell ESA and a QTP in the same year, and the total distribution is more than the beneficiary's adjusted qualified higher education expenses, those expenses must be allocated between the distribution from the Coverdell ESA and the distribution from the QTP before figuring how much of each distribution is taxable. The following two examples illustrate possible allocations.

Example 1. In 2016, Beatrice graduated from high school and began her first semester of college. That year, she had $1,000 of qualified elementary and secondary education expenses (QESEE) for high school and $3,000 of qualified higher education expenses (QHEE) for college. To pay these expenses, Beatrice withdrew $800 from her Coverdell ESA and $4,200 from her QTP. No one claimed Beatrice as a dependent, nor was she eligible for an education credit. She didn't receive any tax-free educational assistance in 2016. Beatrice must allocate her total qualified education expenses between the two distributions.

Losses on Coverdell ESA Investments

If you have a loss on your investment in a Coverdell ESA, you may be able to deduct the loss on your income tax return. You can deduct the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions to that Coverdell ESA. You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit.

Additional Tax on Taxable Distributions

Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income.

Exceptions. The 10% additional tax doesn't apply to the following distributions.

For more information on qualified performing artists, see chapter 6 of Pub. 463.

Recordkeeping

RECORDS: You must keep records as proof of any deduction claimed on your tax return. Generally, you should keep your records for 3 years from the date of filing the tax return and claiming the deduction.

If you are an employee who is reimbursed for expenses and you give your records and documentation to your employer, you don't have to keep duplicate copies of this information. However, you should keep your records for a 3-year period if:

Victor Jones teaches math at a private high school in North Carolina. He was selected to attend a 3-week math seminar at a university in California. The seminar will improve his skills in his current job and is qualifying work-related education. He was reimbursed for his expenses under his employer's nonaccountable plan, so his reimbursement of $2,100 is included in the wages shown on his Form 1040.

His actual expenses for the seminar are as follows.

 Lodging            $1,050

Since he doesn't claim any vehicle expenses, Victor leaves Part II blank. His filled-in form is shown on the next page.

If you have questions about a tax issue, need help preparing your tax return, or want to download free publications, forms, or instructions, go to IRS.gov and find resources that can help you right away.

Preparing and filing your tax return. Find free options to prepare and file your return on IRS.gov or in your local community if you qualify.

The Volunteer Income Tax Assistance (VITA) program offers free tax help to people who generally make $54,000 or less, persons with disabilities, the elderly, and limited-English-speaking taxpayers who need help preparing their own tax returns. The Tax Counseling for the Elderly (TCE) program offers free tax help for all taxpayers, particularly those who are 60 years of age and older. TCE volunteers specialize in answering questions about pensions and retirement-related issues unique to seniors.

You can go to IRS.gov and click on the Filing tab to see your options for preparing and filing your return which include the following.

Using direct deposit. The fastest way to receive a tax refund is to combine direct deposit and IRS e-file. Direct deposit securely and electronically transfers your refund directly into your financial account. Eight in 10 taxpayers use direct deposit to receive their refund. IRS issues more than 90% of refunds in less than 21 days.

Delayed refund for returns claiming certain credits. Due to changes in the law, the IRS can't issue refunds before February 15, 2017, for returns that claim the earned income credit (EIC) or the additional child tax credit (ACTC). This applies to the entire refund, not just the portion associated with these credits.

Getting a transcript or copy of a return. The quickest way to get a copy of your tax transcript is to go to IRS.gov/transcripts. Click on either "Get Transcript Online" or "Get Transcript by Mail" to order a copy of your transcript. If you prefer, you can:

Understanding an IRS notice or letter. Go to IRS.gov/notices to find additional information about responding to an IRS notice or letter.

Contacting your local IRS office. Keep in mind, many questions can be resolved on IRS.gov without visiting an IRS Tax Assistance Center (TAC). Go to IRS.gov/letushelp for the topics people ask about most. If you still need help, IRS TACs provide tax help when a tax issue can't be handled online or by phone. All TACs now provide service by appointment so you'll know in advance that you can get the service you need without waiting. Before you visit, go to IRS.gov/taclocator to find the nearest TAC, check hours, available services, and appointment options. Or, on the IRS2Go app, under the Stay Connected tab, choose the Contact Us option and click on "Local Offices."

Watching IRS videos. The IRS Video portal (IRSvideos.gov) contains video and audio presentations for individuals, small businesses, and tax professionals.

Getting tax information in other languages. For taxpayers whose native language isn't English, we have the following resources available. Taxpayers can find information on IRS.gov in the following languages.

The Taxpayer Advocate Service Is Here To Help You

What is the Taxpayer Advocate Service? The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that helps taxpayers and protects taxpayer rights. Our job is to ensure that every taxpayer is treated fairly and that you know and understand your rights under the Taxpayer Bill of Rights.

What Can the Taxpayer Advocate Service Do For You? We can help you resolve problems that you can't resolve with the IRS. And our service is free. If you qualify for our assistance, you will be assigned to one advocate who will work with you throughout the process and will do everything possible to resolve your issue. TAS can help you if:

How Can You Learn About Your Taxpayer Rights? The Taxpayer Bill of Rights describes 10 basic rights that all taxpayers have when dealing with the IRS. Our Tax Toolkit at taxpayeradvocate.irs.gov can help you understand what these rights mean to you and how they apply. These are your rights. Know them. Use them.

How Else Does the Taxpayer Advocate Service Help Taxpayers? TAS works to resolve large-scale problems that affect many taxpayers. If you know of one of these broad issues, please report it to us at IRS.gov/sams.

Low Income Taxpayer Clinics

Low Income Taxpayer Clinics (LITCs) serve individuals whose income is below a certain level and need to resolve tax problems such as audits, appeals, and tax collection disputes. Some clinics can provide information about taxpayer rights and responsibilities in different languages for individuals who speak English as a second language. To find a clinic near you, visit IRS.gov/litc or see IRS Publication 4134, Low Income Taxpayer Clinic List.

Appendices

The following appendices are provided to help you claim the education benefits that will give you the lowest tax.

Dave and Valerie Jones are married and on their 2016 joint tax return they claim exemptions for their two dependent children, Sean (age 22, social security number: 000-00-0001) and Carey (age 18, social security number: 000-00-0002). Their modified adjusted gross income (MAGI) on Form 1040, line 38, is $121,000. Because Dave and Valerie have unusually high itemized deductions, their taxable income is $10,000 and their tax before credits is $1,003.

Sean enrolled as a full-time graduate student in August 2016 at California State College. He graduated with his bachelor's degree in 2015 and didn't attend school from January 2016 through July 2016. His parents claimed the American opportunity credit for Sean for 2012, 2013, 2014, and 2015.

Carey enrolled full-time as a freshman at the same college in January 2016 to begin working on her bachelor's degree.

In 2016, Dave and Valerie paid $7,000 in tuition for Sean and $8,000 in tuition and $500 for mandatory course materials, not purchased from the college, for Carey. Carey received a $2,000 scholarship.

California State College issued two Forms 1098-T, one for Sean and one for Carey, and sent them to the Joneses residence. The $2,000 scholarship that Carey received is reported in box 5 of her Form 1098-T. California State College reports amounts billed in 2016 instead of amounts paid during 2016. In completing Form 8863, the Joneses should include actual adjusted qualified education expenses paid, or deemed to have been paid, which may be different from what is reported on Form 1098-T. Therefore, the Joneses use the amounts they paid for tuition and mandatory course materials. Because the scholarship Carey received was applied to tuition (a qualified expense), they don't include that in the amount they paid for qualified tuition expenses. Neither Sean nor Carey has been convicted of a felony for possession or distribution of a controlled substance before the end of 2016.

Dave and Valerie figure their education credits by completing Form 8863. They begin Form 8863 on page 2 before completing Part I on page 1. Because the Joneses have two eligible students, they will complete page 2 twice, once for their son, Sean, and once for their daughter, Carey.

The Joneses decide to complete Part III for Carey first, as shown later. They carry over the amount of $2,500 entered on Part III, line 30, to Part I, line 1.

The Joneses complete a separate Part III for their son Sean. They check the "Yes" box on line 23, determine that Sean isn't eligible for the American opportunity credit, and go to line 31 as instructed. They figure their line 31 adjusted qualified education expenses for Sean to be $7,000.

Once they have completed Part III for each student, they figure their credits. The Joneses figure their refundable American opportunity credit of $1,000 by completing Form 8863, Part I, lines 1 through 8. They enter the amount from line 8, $1,000, on line 68 of their Form 1040.

The Joneses enter $7,000 on Part II, line 10, of Form 8863 and figure their tentative lifetime learning credit for 2016 to be $1,400 (line 12). They can't claim the full amount because their MAGI of $121,000 is greater than $111,000. They enter the reduced amount of $700 (figured on Part II, line 18) on the Credit Limit Worksheet, line 1. The $700 is added to their nonrefundable American opportunity credit ($1,500 on line 2 of the Credit Limit Worksheet) for a total nonrefundable credit of $2,200. The Joneses enter $1,003 on line 7 of the Credit Limit Worksheet, which is the smaller of their tax from line 47 of their Form 1040 (which is $1,003) or the $2,200 on line 3 of the Credit Limit Worksheet. They enter $1,003 on Form 8863, Part II, line 19, and on Form 1040, line 50.

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 This chart highlights some differences among the benefits discussed

The education benefits included in this publication were enacted over many years, leading to a number of common terms being defined differently from one benefit to the next. For example, an eligible educational institution means one thing when determining if earnings from a Coverdell education savings account aren't taxable and something else when determining if a scholarship or fellowship grant isn't taxable.

For each term listed below that has more than one definition, the definition for each education benefit is listed.

Academic period: A semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.

Adjusted qualified education expenses (AQEE): Qualified education expenses (defined later) reduced by any tax-free educational assistance, such as a tax-free scholarship or employer-provided educational assistance. They must also be reduced by any qualified education expenses deducted elsewhere on your return, used to determine an education credit or other benefit, or used to determine a tax-free distribution. For information on a specific benefit, see the appropriate chapter in this publication.

Candidate for a degree: A student who meets either of the following requirements.

Eligible educational institution:

Modified adjusted gross income (MAGI):

Qualified education expenses: See pertinent chapter for specific items.

Rollover: A tax-free distribution to you of cash or other assets from a tax-favored plan that you contribute to another tax-favored plan.

Transfer: A movement of funds in a tax-favored plan from one trustee directly to another, either at your request or at the trustee's request.