Tuesday, November 24, 2009

TAX PLANNING AND THE AMERICAN OPPORTUNITY CREDIT

In this past Saturday’s edition of the BUZZ I told you about the finding of a Treasury Inspector General for Tax Administration (TIGTA) review of the education tax credits.

TIGTA's review looked at taxpayers who claimed the credit in 2006 and 2007 and found that, in 2006, approximately 203,000 taxpayers erroneously claimed a total of over $300 million in Hope Credits. In 2007, over 169,000 taxpayers erroneously claimed a total of over $232 million in Hope Credits.”

Well that is nothing compared to what will happen with 2009 and 2010 returns, when the HOPE credit becomes the American Opportunity Credit and, as such, becomes partially refundable.

Hey, we all know by now that refundable credits are basically an open invitation to commit tax fraud.

Some background on the AOC-

The new American Opportunity Credit modifies the existing HOPE Credit for tax years 2009 and 2010. The “new and improved” HOPE Credit is now available to many more taxpayers, including those with higher incomes, as the AGI phase-out range is $80,000 - $90,000 for singles and $160,000 - $180,000 for married couples, and those who owe no tax, as it is partially refundable. It also adds required course materials (“books, supplies and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance”) to the list of qualifying expenses, and allows the credit to be claimed for four post-secondary education years instead of two. The maximum credit has also been increased to $2,500 per student.

Click here to go to the IRS page of American Opportunity Credit: Questions and Answers.

Despite the increased AGI phase-out range, many parents with dependents attending college will still be unable to receive any tax benefit, especially in my neck of the woods. However, there is HOPE (no pun intended).

IRS Field Service Advice FSA 200236001 tells us that there is a way for a dependent child to claim the HOPE Scholarship credit.

James Q Taxpayer, the son of John Q and Jane Q, was an unmarried full-time college student who had net taxable income for the year. John and Jane were entitled to claim James as a dependent.

During the year, James incurred expenses that qualified for the HOPE education credit. However, John and Jane's Adjusted Gross Income (AGI) was in excess of the maximum AGI threshold, and could not claim the credit.

James' tax liability, before any credits, was more than the amount of combined federal and state tax savings John and Jane would have realized by claiming James as a dependent.

John and Jane, although entitled to, did not claim James as a dependent on their 1040. James filed a tax return, but did not claim an exemption for himself. James did, however, claim the HOPE Scholarship credit on his return.

The National Office of the IRS has concluded that because the parents (John and Jane) could claim a dependency exemption for the "child" (James), he (James) could not claim an exemption for himself. But, as the parents did not claim the child as a dependent, the child (James) was entitled to claim the HOPE Scholarship credit on his return if he met the eligibility requirements.

I know of no reason why this will not also apply to the American Opportunity Credit.

This “loophole” suggests a tax planning opportunity. If the taxable income of James above, the dependent student, can be controlled it would be good to make sure James earns at least enough to generate a tax liability that assures he will be able to take full advantage of the American Opportunity Credit, including its refundable portion. {OOPS! CLICK HERE TO READ A CORRECTION - rdf}

It may be too late to generate sufficient income for a qualifying dependent student for 2009 – but there is still 2010.

TTFN

2 comments:

mok said...

By the way, for anyone trying to get a quick overview of basic tax laws affecting working families and senior citizens, I highly recommend the VITA training materials, which the IRS has put out earlier than usual this year. There will, of course, be additional information in the Pub 17 when it comes out, and additional information as the IRS digests all the implications of the tax law changes, but the VITA training materials, especially Pub 4012, are a good place to get a lot of basic nuts and bolts questions answered. I'm still going through this year's 4012 to add more highlighting, buffalo stamps, and red sticky note annotations for my students, which I also make available to the interested world at large.

Robert D Flach said...

MOK-

I believe that comments to posts are not always read as much as the actual posts.

Your comment on the FU in my post was important enough that I felt it required mention in a "normal" post.

So rather than publishing your comment as a comment, which might get "lost in the shuffle", I wrote my subsequent post explaining the error you discovered.

Thanks again for pointing it out. I rely on my fellow tax bloggers to "keep me honest".

Happy Thanksgiving!

TWTP