About 20 years ago, under the Clinton administration, the country took a turn toward paying for college – that is, helping to pay for it via an income tax credit. This was named The Hope credit, and it allowed undergraduate students to save taxes based on college tuition. However, you could only claim the credit for two tax years. Our attitude at the time, therefore, was to not delve into complicated issues. With the many questions surrounding yeshivas and Israel programs, we simply waited to use the credit until the student was attending a “real college,” when there were no doubts.
Ten years ago, however, the tax credit was renamed the American opportunity tax credit (AOTC) and extended to four tax years. This forced some important questions and issues, especially in the frum world. So, this article is 10 years overdue – but better late than never.
This is what the AOTC offers: You get a tax credit of 100% of the first $2,000 spent and 25% of the second $2,000. A tax credit is dollar for dollar. Therefore, you can save $2,500 if you spend $4,000 on college. This is per person, with no limit on the number of people.
The Ten Commandments of the AOTC
- You can claim this credit for college costs incurred for any of your dependents.
- You can claim this credit for maximum of four tax years per person.
- The student must be pursuing a degree or credential.
- You income cannot exceed $180,000. The credit “phases out” as income goes from $160,000 to $180,000.
- You can only claim this credit for the first four years of college.
- The student must be enrolled in an eligible educational institution (includes trade schools).
- The student must be enrolled at least half-time for at least one semester.
- The money can be spent on tuition, supplies, books, and fees (not room, board, or travel).
- You need to receive form 1098-T from the college. The college issues this tax form to every student (and a copy goes to the IRS).
- The student must have no conviction for drugs.
Now, in case these 10 rules seem straightforward, sit tight, folks, and keep reading. Indeed, for Johnny and Mary, attending Towson State for four years, it really is simple. For many people, however, none of the rules is clear.
The Rules with Commentary
Before we get started, let me state that tuition must be paid by someone. If it is paid with loans, that is okay. If it is paid with only 529 money, however, it does not work. If you have a 529 plan, you had better know what you are doing. I’ll leave it at that. If you are receiving grants for all of your tuition, get advice.
Rule 1: Being a dependent. Whoever claims the student as a dependent gets to claim the benefit. Important - it does not matter who paid for the college - it could have been uncle George from Chicago or it could have been student loans. Still if the parents claim the student on their return then they get the benefit of the college tuition that they never paid for. As long as “it got paid” somehow, the parents benefit.
Now sometimes, the student makes money, and it is not clear at all who should claim the student as a dependent. This is because it is not clear who “supported” this student. It can make an enormous difference. It gets worse - once the child turns 24, there is a strict IRS law that disallows the child as a dependent if that child earned more than about $4,000 per year. If the student earns too much then the parent cannot claim this student as a dependent EVEN IF the parents support the student. And if you cannot claim them as a dependent then you cannot claim tax benefits for their college costs.
Rule 2: Four tax years max. This means that you can claim the credit for four calendar years. Actually, this one is also complicated. Imagine a boy who takes eight years to finish college. This is more common than you think with yeshiva followed by college. Now imagine that the student goes to yeshiva and his parents claim the credit. Then the student gets married and attends four years of secular college. Can the student claim the credit if his father already claimed it? If he does claim it, can the IRS tell him that his father already claimed it? Actually, they cannot disclose to the student any aspect of the father’s return. Disclosing this credit would also reveal the father’s income range, so it is confidential. This question is therefore not answerable.
Rule 3: Pursuing a degree. I have never heard of anyone losing on this one because it seems to be based upon your intent, which no one can challenge. I think that any time you are in college you are pursuing a degree or other credential simply by accumulating credits. However, let’s say that the student is taking six or more credits at community college. The student has no idea what she is “going to do when she grows up” and has no plans where she will finish college. I would still claim it but there is a question here.
Rule 4: Income not exceeding $180,000. Try to keep your income below 160K. You can lower income by putting money into a 401(k). If the parent earns $180,000, he cannot claim this credit at all. He might have several kids who are college students. By bringing his income down to $160,000, he can see a potential 75% tax savings on his 401(k) contributions. Pretty amazing!
Clearly, do not do anything to push UP your income. This might happen if the parents sell stock to pay for college. It would make more sense to gift the shares to the student and have the student sell the shares, but this is getting complicated so don’t try this at home.
Rule 5: Only first four years of college. What does this mean? What if you cross the finish line of four college years during the year? This question was answered by the IRS, which said that it is based upon your status at the beginning of the year. But what are four years of college if not calendar years? Answer: It seems that once you have taken enough credits to get a bachelor degree, you have finished four years. You could accomplish this in less than four years if you are smart. This is a big issue with frum people, who often finish college quickly in the various programs that accept yeshiva credits.
What if you finish college at college A and then attend college B, which will not accept the credits from college A? In that case, your status is determined by your “current college,” and your four years are indeed starting over. Strategy tip: Delay completion until after January 1, to give yourself one more year to claim this credit.
Rule 6: Enrolled in an eligible educational institution. Eligible here means eligible to receive Pell funds from the government. Here, too, there is a problem. The rules say “eligible to participate.” What if the college is eligible but they have not completed their approval process? Unclear. However, the IRS has a link to a site that has a list of every college and trade school that is accredited to receive Pell money.
This one is also of extreme importance for frum people. Clearly, if you are only enrolled in a yeshiva that is not eligible, you do not qualify. But let’s take the “Israel question.” The student is enrolled at Yeshiva University but then attends school in Israel. YU is “running the program.” However, the checks are written to yeshiva X that has no standing in the U.S. This is a gray area, but I have always argued that the Israel costs do indeed qualify, and I know several people who have won audits. I argue that the Israel program is part of YU. I genuinely believe the government never even contemplated some of these situations when they made these rules.
Rule 7: Enrolled half-time. On form 1098-A, there is a check box asking whether you are half-time. Here is the issue: Let’s go back to the Israel question. The 1098-T from YU might not show that you are not half-time – because in their institution you are not enrolled half-time. When you add the Israel activity, however, you are half-time.
A second issue: Let’s say you take three credits at Baltimore City Community College and three credits at Towson University. Both colleges issue a 1098-T indicating that you are not a full-time student. However, when you add the credits, you have six credits. Six credits is indeed half-time for the community college, since they deem 12 credits to be full time. At Towson, however, 15 credits is full time, and therefore even six is under half time. Do I add the Towson credits to the BCCC credits and claim it, or go the other way and not claim it? This is starting to shout out to King Solomon for some wisdom.
Rule 8: Tuition but not room and board, etc. Here, too, we need to count the Israel money to add up to the needed $4,000. Keep good records to explain the whole system. I have seen situations in which a student has a full scholarship and spends nothing on college. But the first $2,000 spent on supplies and books will count. You might as well spend it to get back dollar for dollar. Yep, you can spend $2,000 on computer equipment and get all your money back. Good deal!
Another big question: Only money spent on tuition and not room and board counts. Let us say that student attends yeshiva A that is accredited. Full tuition is $15,000. The student only pays $4,000 because of a tuition reduction. Is that $4,000 for tuition or room and board? Which one was forgiven? Can I argue that all the room and board was forgiven and only tuition remains? Can the yeshiva say to me to do whatever I want? Do they need to weigh in officially? It might be wise to get something in writing.
Rule 9: Must receive form 1098-T from the college. Clearly, that form will not indicate the tuition paid directly to Israel. That does not invalidate it, but it creates a challenge. This form provides limited information and is notoriously confusing. The form gives information regarding tuition cost and also it states whether the student is full-time and if he or she is graduate level. If these boxes are not checked, we assume the default is that the student is not a graduate student and less than half-time.
Rule 10: No drug conviction. Let’s assume this is not an issue. But if it is, you should work hard to keep a conviction off your record, or you will lose all these tax goodies that could tally up to $10,000. Remember you can receive $2,500 for four years!
Strategies for Dual School Students
The predominant issue for the frum community is students enrolled in an accredited college and non-accredited yeshiva/seminary for the same semester. This affects rules 5, 6, 7, 8, and 9. (Yikes!) Here are some ideas:
- Try to get the college to issue a form 1098-T for each calendar year in play.
- Get a transcript from the college showing all the credits you are taking during the years in question. This will establish half-time status and also justify claiming Israel tuition expenses, since those courses will appear on the transcript from the “real” college.
- Obviously, when you are paying for Israel, make sure that at least $4,000 in expenses is paid in each calendar year. I have seen disasters where the last check is dated Dec 31. This can cause a loss of $2,500, since you will have nothing to claim for year two.
- Have copies of all checks and/or credit card charges.
- Most importantly, before going to Israel make sure you are actually enrolled in an American college. This is becoming more difficult as American yeshiva colleges (YU, Touro, and Skokie) demand that the student continue at the college upon return from Israel. They are getting pressure from the federal government.
Other Issues for the Frum Community
1) Many Bais Yaakov girls take college courses and might qualify. However, they are currently not receiving a 1098-T, which is necessary to claim this. Maybe that can change.
2) Imagine the following: A boy comes back from Israel and enters the famous BMG “freezer.” Six months later he is engaged. When he gets married, he will stop paying tuition to the yeshiva, but he is still a student. Now, a Shas (set of Talmud traditionally given to the boy) is bought for him by his wonderful father-in-law. This Shas is clearly college books for a yeshiva student. It might therefore qualify for this credit. This means that the father of the boy might get refunded dollar for dollar for the Shas that was bought by the father of the girl. Try to explain all this frum stuff to the IRS!
3) What if, after reading this article, you discover that you have failed to claim what you are entitled to? Well, you could amend your returns going back three years, but, of course, amending always draws more scrutiny than doing the return correctly the first time.
4) I have a dream: Wouldn’t it be amazing if students could enroll in a school such as Touro and indeed continue upon their return through an online study program? If anyone out there knows if such a program already exists, please email me, and I’ll update everyone next month.
We see how complicated all this has become and how the frum community is especially affected. There is a lot of money at stake, so we need to be diligent and make sure we are following all the rules to be able to qualify.
The Lifetime Learning Credit
There is a second tax credit, called the lifetime learning credit, which is generally used for graduate school and has a lower income test. It is limited to 20% of max $10,000 in tuition per family! Most of the above-mentioned issues do not arise. You are not limited to undergraduate, do not need to be half-time, and there is no limit to how many years you can get it. Most students going for their masters are in a real college, so this one goes pretty smoothly. However, time your payments so that you max out the number of years.
A caveat: There are no guarantees. Any auditor could deny the credit for dual students, and your only recourse would be to proceed to Tax Court. Chances are you will back down because you will feel overwhelmed by this process of dealing with tax court. If any of you have stories of IRS audits or issues, please email me so I can learn from you and perhaps update this article. Obviously, I will keep your identity secret. Thanks!
Eli Pollock CPA can be reached at elipollock2@yahoo.com.
