Electing Out Of & Maximizing the Hope Credit

CAUTION: This article does not apply to tax years 2009 through 2012 since the American Opportunity Credit replaces the Hope Scholarship Credit for those years.

For taxpayers that strive to maximize their tax benefits, the Hope education credit can be challenging. Generally, students enter college in the fall of their first year, thus making the first year a short one.

If the credit is taken in the first year, the credit would only be allowed for one more tax year since the Hope credit can only be taken in two calendar years, even though the student will probably qualify for the Hope credit in the next two full years. The rules associated with the credit do provide some planning flexibility, so let's first review the key points:

  • The ability to "elect" not to claim the credit in a particular year for a student.
  • The Hope credit cannot be claimed for more than two tax years whether or not consecutive, and
  • The Hope credit is allowed for the first two years of post-secondary education. (The Hope credit isn't allowed for a tax year with respect to the qualified tuition and related expenses of a student if the student has completed (before the beginning of that tax year) the first two years of post-secondary education at an eligible educational institution.
  • If qualified tuition and related expenses are paid during one tax year for an academic period that begins during the first three months of the taxpayer's next tax year (i.e., in January, February, or March of the next tax year for calendar-year taxpayers), an education credit is allowed with respect to the qualified tuition and related expenses only in the tax year in which the expenses are paid.

Since the determination of whether the student is in the first two years of post-secondary education is made at the beginning of each tax year, most full-time students will be considered to be in their first two years of post-secondary education in the first three years of college. This requires planning to maximize the deduction. A taxpayer must carefully match the facts of the situation with the rules associated with the credit to determine the best course of action for the client. The scenarios can be endless. The following are examples of some possible situations:

Student is in the first year so the credit would be small and claiming it would eliminate one year's credit opportunity. Solution A: The taxpayer could elect out of the Hope credit for that year and preserve the credit for two subsequent years. Solution B: The taxpayer could prepay the tuition for an academic period beginning in January, February or March of the subsequent year, thus increasing the tuition expense for the current year. Although, that would decrease the tuition expense for the subsequent year!

Taxpayer's AGI will phase them out of the credit. Solution A: This automatically elects them out for that year, preserving the credit opportunity for other years in which they qualify. Solution B: Prepay the tuition for an academic period beginning in January, February or March in the prior year if possible.

First year of post-secondary education is at a local junior college and subsequent years will be at a more expensive university. Solution: Taxpayer can elect out of the Hope credit in the first year and take it for the more expensive university tuition in any two subsequent years if the student has not completed the first two years of post-secondary education at the beginning of the subsequent years.

Parents are divorced and they alternately claim the student as a dependent. One parent pays the tuition for all years. Solution: Since the credit goes to the one who claims the dependency, the parents could plan the dependency to maximize the credit itself or force the credit to a particular parent.

In the years the Hope credit is not claimed, the lifetime credit can be claimed. Since the requirement for the Hope credit is attending college at least half-time, it is possible that some students may be in their first two years of post-secondary education for more than three years.

As you can see, the situations are endless. However, keep in mind that this requires forward-looking assumptions that might not materialize. The AGI limitations might unrepentantly kick in, the student might drop out of school, etc.

Please call this office if we can be of assistance in helping you establish an education plan for your children. There other strategies that can be employed as well.