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Which tax benefit for education is partially refundable?

Which tax benefit for education is partially refundable?

Education is often seen as the key to success and a better future. It opens doors to opportunities, increases earning potential, and improves overall quality of life. However, the cost of higher education has been steadily rising, making it difficult for many individuals and families to afford. According to the College Board, the average cost of tuition and fees for the 2020-2021 school year was $10,560 for in-state public colleges and $37,650 for private colleges. This does not include additional expenses such as room and board, textbooks, and other fees.

As a result, many students and their families turn to financial aid and tax benefits to help offset the cost of education. One type of tax benefit that is available is the partially refundable tax credit. In this article, we will explore what a partially refundable tax credit is and which tax benefit for education falls under this category.

Understanding Tax Credits and Refundable Tax Credits

Before we dive into the specific tax benefit for education that is partially refundable, it is important to understand the concept of tax credits and refundable tax credits.

A tax credit is a dollar-for-dollar reduction in the amount of taxes owed. This means that if you owe $5,000 in taxes and have a $1,000 tax credit, your tax liability will be reduced to $4,000. Tax credits are more beneficial than tax deductions, which only reduce the amount of taxable income.

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Refundable tax credits, on the other hand, not only reduce the amount of taxes owed but can also result in a refund if the credit exceeds the taxes owed. For example, if you owe $3,000 in taxes and have a $4,000 refundable tax credit, you will not only have a zero tax liability but will also receive a $1,000 refund.

Now that we have a basic understanding of tax credits and refundable tax credits, let’s take a closer look at the tax benefit for education that falls under the partially refundable category.

The American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a tax credit that was created as part of the American Recovery and Reinvestment Act of 2009. It was originally set to expire in 2010 but has been extended multiple times and is currently available until the end of 2025.

The AOTC is a partially refundable tax credit that provides up to $2,500 per eligible student for the first four years of post-secondary education. This includes undergraduate and graduate studies. The credit is based on 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000, for a maximum credit of $2,500.

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In order to be eligible for the AOTC, the student must be pursuing a degree or other recognized education credential, enrolled at least half-time for at least one academic period during the tax year, and have not completed the first four years of post-secondary education. The student must also not have any felony drug convictions and must not have claimed the AOTC or the former Hope credit for more than four tax years.

Additionally, the AOTC has income limits. For single filers, the credit begins to phase out at a modified adjusted gross income (MAGI) of $80,000 and is completely phased out at $90,000. For married couples filing jointly, the phase-out range is $160,000 to $180,000.

How the AOTC Works

Let’s take a look at an example to better understand how the AOTC works. Sarah is a full-time undergraduate student at a public university. She paid $5,000 in qualified education expenses for the tax year. Her parents claim her as a dependent on their tax return and have a MAGI of $85,000.

Based on the AOTC formula, Sarah is eligible for a credit of $2,500 (100% of the first $2,000 and 25% of the next $2,000). However, since the AOTC is partially refundable, her parents will only receive a credit of $2,000 (100% of the first $2,000 and 25% of the remaining $3,000). This will reduce their tax liability by $2,000. If their tax liability is less than $2,000, they will receive a refund for the remaining amount.

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It is important to note that the AOTC can only be claimed for the same student for a maximum of four tax years. After that, the Lifetime Learning Credit (LLC) can be claimed for the same student.

The Lifetime Learning Credit (LLC)

The Lifetime Learning Credit (LLC) is another tax benefit for education that is partially refundable. It was created to help individuals and families with the cost of post-secondary education, including undergraduate, graduate, and professional degree courses. Unlike the AOTC, there is no limit on the number of years the LLC can be claimed for the same student.

The LLC provides a tax credit of up to $2,000 per tax return, based on 20% of the first $10,000 of qualified education expenses. This means that the maximum credit is $2,000 per tax return, regardless of the number of students in the family. The credit is also non-refundable, which means it can only reduce the tax liability to zero and cannot result in a refund.

Similar to the AOTC, the LLC also has income limits. For single filers, the credit begins to phase out at a MAGI of $59,000 and is completely phased out at $69,000. For married couples filing jointly, the phase-out range is $118,000 to $138,000.

How the LLC Works

Let’s continue with the example of Sarah. If her parents are not eligible for the AOTC, they can claim the LLC instead. Based on their MAGI of $85,000, they are eligible for a credit of $1,000 (20% of the first $5,000 of qualified education expenses). This will reduce their tax liability by $1,000. If their tax liability is less than $1,000, they will not receive a refund for the remaining amount.

It is important to note that the AOTC and LLC cannot be claimed for the same student in the same tax year. However, if the student’s qualified education expenses exceed $10,000, the AOTC can be claimed for the first $10,000 and the LLC can be claimed for any additional expenses.

Which Tax Benefit for Education is Partially Refundable?

After understanding the AOTC and LLC, it is clear that the AOTC is the tax benefit for education that is partially refundable. This is because it not only reduces the tax liability but can also result in a refund if the credit exceeds the taxes owed.

The LLC, on the other hand, is non-refundable and can only reduce the tax liability to zero. This means that if the credit exceeds the taxes owed, the remaining amount will not be refunded.

Why is the AOTC Partially Refundable?

The AOTC was designed to help make higher education more affordable for students and their families. By making it partially refundable, it provides additional financial assistance to those who may not have a high tax liability but still have significant education expenses.

For example, a student who is claimed as a dependent on their parents’ tax return may not have a high tax liability, but they still have education expenses that need to be paid. The partially refundable nature of the AOTC allows them to receive a refund for the remaining credit, providing much-needed financial support.

Conclusion:

In conclusion, the American Opportunity Tax Credit (AOTC) is the tax benefit for education that is partially refundable. It provides up to $2,500 per eligible student for the first four years of post-secondary education and is based on 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000. The AOTC is designed to make higher education more affordable and provides additional financial assistance to those who may not have a high tax liability but still have significant education expenses.

It is important for individuals and families to understand the different tax benefits available for education and how they can help offset the cost of higher education. By taking advantage of these tax benefits, students and their families can ease the financial burden and focus on achieving their educational goals.

Remember to consult with a tax professional or use tax preparation software to determine your eligibility and accurately claim the AOTC or LLC on your tax return. With the rising cost of education, every little bit helps, and these tax benefits can make a significant difference in the long run.

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