Question

Kyle and Tess Water are married, file a joint return, and have two dependent children in college, Luke and Taylor. Luke attends a State University in a neighboring state, and Taylor attends a State University in their home state. Neither receives any type of financial assistance. The Water modified AGI in 2017 is $119,000. The children's classifications and expenses are as follows:

Spring Semester

(paid in January 2017) (paid in July 2017)

Luke: Senior Master's candidate

Tuition $7,400 $8,200

Laboratory fees 550 550

Student activity fees 300 300

Course materials (books) 450 500

Room and board 3,000 3,000

Taylor: Sophomore Junior

Tuition $1,550 $1,650

Student activity fees 300 300

Course materials (books) 150 275

Room and board 3,300 3,900

a. Compute any education credits that the Waters may claim in 2017.

(Assume that both Luke and Taylor qualify as eligible students for the American Opportunity Tax Credit.)

b. How would your answer in Part a change if Luke received an academic scholarship of $2,600 (excluded from gross income) for each semester?

c. How would your answer in Part a change if Kyle and Tess's modified AGI for

2017 was $172,000?

d. How would your answer in Part a change if Luke had been a junior during Spring semester and a senior during Fall semester?

Answer 1

a. AOTC = 100% of first $2,000 qualified education expenses + 25% of up to next $2,000 of qualified education expenses

Because the Waters’ 2017 AGI does not exceed $160,000, their AOTC will not be reduced by phaseout.

Luke:

2017 Qualified education expenses = $17,650 = ($7,400 + $8,200 + $550 + $550 + $450 + $500) Tentative & Allowed AOTC = 100%($2,000) + 25%( $2,000) = $2,500

Taylor:

2017 Qualified education expenses = $3,625 = ($1,550 + $1,650 + $150 + $275)

Tentative & Allowed AOTC = 100% ($2,000) + 25% ($1,625) = $2,406.25

Notes:

For luke and Taylor to qualify as eligible students, each must

1) Not have used the AOTC for 4 prior tax years,

2) Not have completed the first 4 years of postsecondary education (evaluated at beginning of 2017),

3) Have been enrolled at least half-time in a degree program (or other credential), AND

4) Not have been convicted of a felony drug offense (evaluated at end of tax year)

Taylor appears to meet all 4 conditions.

luke appears to meet conditions 2), 3), and 4).

The solution above assumes he meets condition 1) for 2017 (AOTC has not been used for luke’s expenses in 4 prior tax years), meaning for Spring 2017 and Fall 2017, he qualifies as an eligible student for AOTC.

If instead, the AOTC has already been used for luke’s expenses in 4 tax years before 2017, his qualified education expenses do not qualify for the AOTC. Instead, the Lifetime Learning Credit (LLC) should be used for luke’s 2017 qualified education expenses.

LLC = 20% (qualified education expenses up to $10,000 per year)

luke:

Qualified education expenses = ($7,400 + $8,200 + $550 + $550) = $16,700 Tentative LLC = 20% ($10,000) = $2,000

LLC after phaseout = $2,000 – $900 ** = $1,100

**LLC Phaseout: $2,000*($119,000 - $110,000)/$20,000 = $900

^aIRC Section 25A(b)(2)(C), IRC Section 25A(i)(2), and Reg. Section 1.25A-3(d)(1)(iii) consistently indicate evaluation of whether a student has completed four years of study should occur at the beginning of the tax year. Example 2 in IRS Publication 970 (dated 1/7/2014) characterizes as an eligible student one who was considered a second-semester senior for the 2013 spring semester and a first semester graduate student in the 2013 fall semester. The example indicates the qualified education expenses for both spring and fall semesters in 2013 are eligible for the AOTC in 2013.

b. luke’s qualified education expenses must be reduced by the scholarship ($17,650-2($2,600) = $12,450). His expenses remain high enough to yield the maximum tentative AOTC (and tentative LLC if – as described in part a – he has already used AOTC in 4 prior tax years).

Tentative AOTC = 100%($2,000) + 25%( $2,000) = $2,500

c. With AGI of $172,000, phaseout will reduce the AOTC allowed.

Combined tentative AOTC = $2,500 + $2,406 = $4,906

Allowed AOTC = $4,906 - $4,906[($172,000 - $160,000)/$20,000] = $1,962

d. The answer would have been the same. luke’s status as a qualified student for AOTC is based on his progress as a student at the beginning of each tax year. In both scenarios – with luke as a junior and as a senior – luke has not completed the first four years of postsecondary education.