The benefit of the education tax credit is twofold: It gives children from families who are not well-to-do a chance to acquire a college education and provides adults the opportunity to enhance their skills. For lower- and moderate-income families, the American Opportunity Tax Credit and the Lifetime Learning Credit are two federal tax credits that ease the financial burden of earning a degree or acquiring a skill. To claim the tax credit, you complete the Internal Revenue Service (IRS) Form 8863.
What Is an 8863 Tax Credit?
Unlike a deduction, which reduces the taxpayer's taxable income, the 8863 tax credit reduces the taxpayer's tax liability. The value of a tax credit depends on the nature of the credit.
As with other tax credits, a taxpayer can deduct the 8863 qualified expense via the American Opportunity Tax Credit or the Lifetime Learning Tax Credit, each of which is deducted from the tax amount she owes to the United States government. The taxpayer is permitted to subtract, dollar for dollar, the Form 8863 credit from the income taxes that she owes.
Tax Deduction vs. Tax Form 8863 Credit
A tax credit is likely to have a more favorable effect on a taxpayer's tax liability than a tax deduction because a tax credit reduces a tax liability dollar for dollar up to an amount stipulated in the tax law. In turn, a deduction reduces the taxpayer's tax liability, but it does so according to an individual's marginal tax rate, or the tax rate the individual pays on each additional dollar of income.
For instance, if the taxpayer is in the 24 percent tax bracket, a tax deduction would save her 24 cents for each marginal tax dollar that a tax deduction allows. In contrast, a tax credit reduces the taxpayer's liability by a full dollar.
Read More: How to Calculate Education Credits
American Opportunity Credit
The American Opportunity Credit (AOC) allows a student or her parent(s) to decrease her or their tax bill by as much as $2,500, assuming that the student spends $2,500 or more pursuing her undergraduate degree.
If so, the undergrad or her parent(s) will claim the first $2,000 of the student's expenses, such as tuition payments, school fees and the costs of books and other supplies, plus 25 percent of her additional education-related costs, excluding living and transportation expenses, up to another $2,000. Consequently, the undergraduate or her parent(s) can claim a total of $2,500 each year the student is enrolled for up to four years.
Individuals Eligible to Claim the Tax Credit
The objective of the AOC is to decrease the financial burden for a student or a parent(s) who pays the costs of the education of the undergraduate. That taxpayer, whether the student or a parent(s), can claim the tax credit each one of the four years that an undergraduate typically requires to complete her studies and earn an undergraduate degree. For the student's parent(s) to claim the credit, the parent must list the student as a dependent on her tax return.
There are also income limits for this credit where exceeding the thresholds means a partial credit or none at all. Those who are married but filing separate returns can't claim the credit.
Read more: Education Credit Vs. Tuition Deduction
Lifetime Learning Credit
The Lifetime Learning Credit (LLC) allows the tax-paying student or her parent(s) to decrease the taxpayer's tax bill by as much as 20 percent of the first $10,000 of school tuition and fees (excluding living and transportation expenses), or $2,000.
Individuals Eligible to Claim the LLC
The LLC lessens the financial burden for a student or a parent(s) who pays for the education of an undergraduate, graduate or non-degree or vocational student. That taxpayer can claim the tax credit each year that the dependent student takes a course to enhance her skills. For a student's parent(s) to claim the credit, she must list the student as a dependent on her tax return.
Like the AOC, the LLC has income limits for filers. In addition, married couples filing separately can't take advantage of this tax benefit.
While taxpayers can claim both the American Opportunity Tax Credit and the Lifetime Learning Credit for a dependent student's education, she can't do so in the same year.