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Handr block 2. Handr block   Employees' Pay Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tests for Deducting PayTest 1—Reasonableness Test 2—For Services Performed Kinds of PayAwards Bonuses Education Expenses Fringe Benefits Loans or Advances Property Reimbursements for Business Expenses Sick and Vacation Pay Introduction You can generally deduct the amount you pay your employees for the services they perform. Handr block The pay may be in cash, property, or services. Handr block It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. Handr block For information about deducting employment taxes, see chapter 5. Handr block You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. Handr block Empowerment zone employment credit (Form 8844). Handr block Indian employment credit (Form 8845). Handr block Work opportunity credit (Form 5884). Handr block Credit for employer differential wage payments (Form 8932). Handr block Reduce your deduction for employee wages by the amount of employment credits you claim. Handr block For more information about these credits, see the form on which the credit is claimed. Handr block Topics - This chapter discusses: Tests for deducting pay Kinds of pay Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits See chapter 12 for information about getting publications and forms. Handr block Tests for Deducting Pay To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. Handr block These and other requirements that apply to all business expenses are explained in chapter 1. Handr block In addition, the pay must meet both of the following tests. Handr block Test 1. Handr block It must be reasonable. Handr block Test 2. Handr block It must be for services performed. Handr block The form or method of figuring the pay does not affect its deductibility. Handr block For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. Handr block Test 1—Reasonableness You must be able to prove that the pay is reasonable. Handr block Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. Handr block If the pay is excessive, the excess pay is disallowed as a deduction. Handr block Factors to consider. Handr block   Determine the reasonableness of pay by the facts and circumstances. Handr block Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. Handr block   To determine if pay is reasonable, also consider the following items and any other pertinent facts. Handr block The duties performed by the employee. Handr block The volume of business handled. Handr block The character and amount of responsibility. Handr block The complexities of your business. Handr block The amount of time required. Handr block The cost of living in the locality. Handr block The ability and achievements of the individual employee performing the service. Handr block The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation. Handr block Your policy regarding pay for all your employees. Handr block The history of pay for each employee. Handr block Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. Handr block Employee-shareholder salaries. Handr block   If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. Handr block The excessive part of the salary would not be allowed as a salary deduction by the corporation. Handr block For more information on corporate distributions to shareholders, see Publication 542, Corporations. Handr block Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. Handr block For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. Handr block Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. Handr block If you give property to an employee as an employee achievement award, your deduction may be limited. Handr block Achievement awards. Handr block   An achievement award is an item of tangible personal property that meets all the following requirements. Handr block It is given to an employee for length of service or safety achievement. Handr block It is awarded as part of a meaningful presentation. Handr block It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. Handr block Length-of-service award. Handr block    An award will qualify as a length-of-service award only if either of the following applies. Handr block The employee receives the award after his or her first 5 years of employment. Handr block The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years. Handr block Safety achievement award. Handr block    An award for safety achievement will qualify as an achievement award unless one of the following applies. Handr block It is given to a manager, administrator, clerical employee, or other professional employee. Handr block During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value). Handr block Deduction limit. Handr block   Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. Handr block $400 for awards that are not qualified plan awards. Handr block $1,600 for all awards, whether or not qualified plan awards. Handr block   A qualified plan award is an achievement award given as part of an established written plan or program that does not favor highly compensated employees as to eligibility or benefits. Handr block   A highly compensated employee is an employee who meets either of the following tests. Handr block The employee was a 5% owner at any time during the year or the preceding year. Handr block The employee received more than $115,000 in pay for the preceding year. Handr block You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding year. Handr block   An award is not a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. Handr block To figure this average cost, ignore awards of nominal value. Handr block Deduct achievement awards as a nonwage business expense on your return or business schedule. Handr block You may not owe employment taxes on the value of some achievement awards you provide to an employee. Handr block See Publication 15-B. Handr block Bonuses You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. Handr block However, the total bonuses, salaries, and other pay must be reasonable for the services performed. Handr block If the bonus is paid in property, see Property , later. Handr block Gifts of nominal value. Handr block    If, to promote employee goodwill, you distribute food or merchandise of nominal value to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. Handr block Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. Handr block For more information on this deduction limit, see Meals and lodging , later. Handr block Education Expenses If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Handr block Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. Handr block For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. Handr block Fringe Benefits A fringe benefit is a form of pay for the performance of services. Handr block You can generally deduct the cost of fringe benefits. Handr block You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. Handr block You also may not owe employment taxes on the value of the fringe benefits. Handr block See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. Handr block Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited. Handr block Certain fringe benefits are discussed next. Handr block See Publication 15-B for more details on these and other fringe benefits. Handr block Meals and lodging. Handr block   You can usually deduct the cost of furnishing meals and lodging to your employees. Handr block Deduct the cost in whatever category the expense falls. Handr block For example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold. Handr block If you operate a nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen service, salaries, depreciation, etc. Handr block Deduction limit on meals. Handr block   You can generally deduct only 50% of the cost of furnishing meals to your employees. Handr block However, you can deduct the full cost of the following meals. Handr block Meals whose value you include in an employee's wages. Handr block Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. Handr block This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience. Handr block Meals you furnish to your employees at the work site when you operate a restaurant or catering service. Handr block Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. Handr block Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). Handr block This does not include meals you furnish on vessels primarily providing luxury water transportation. Handr block Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. Handr block This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. Handr block Employee benefit programs. Handr block   Employee benefit programs include the following. Handr block Accident and health plans. Handr block Adoption assistance. Handr block Cafeteria plans. Handr block Dependent care assistance. Handr block Education assistance. Handr block Life insurance coverage. Handr block Welfare benefit funds. Handr block   You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. Handr block For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc. Handr block ). Handr block Life insurance coverage. Handr block   You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business, if you are directly or indirectly the beneficiary of the policy. Handr block See Regulations section 1. Handr block 264-1 for more information. Handr block Welfare benefit funds. Handr block   A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Handr block Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. Handr block   Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. Handr block If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. Handr block   Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. Handr block The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. Handr block The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. Handr block These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. Handr block   For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. Handr block Loans or Advances You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. Handr block However, if the employee performs no services, treat the amount you advanced as a loan. Handr block If the employee does not repay the loan, treat it as income to the employee. Handr block Below-market interest rate loans. Handr block   On certain loans you make to an employee or shareholder, you are treated as having received interest income and as having paid compensation or dividends equal to that interest. Handr block See Below-Market Loans in chapter 4. Handr block Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. Handr block The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property. Handr block You can claim the deduction only for the tax year in which your employee includes the property's value in income. Handr block Your employee is deemed to have included the value in income if you report it on Form W-2, Wage and Tax Statement, in a timely manner. Handr block You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Handr block Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. Handr block These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. Handr block Restricted property. Handr block   If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. Handr block However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. Handr block    “Substantially vested” means the property is not subject to a substantial risk of forfeiture. Handr block This means that the recipient is not likely to have to give up his or her rights in the property in the future. Handr block Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. Handr block However, your deduction may be limited. Handr block If you make the payment under an accountable plan, deduct it in the category of the expense paid. Handr block For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. Handr block If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. Handr block See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. Handr block Sick and Vacation Pay Sick pay. Handr block   You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. Handr block However, your deduction is limited to amounts not compensated by insurance or other means. Handr block Vacation pay. Handr block   Vacation pay is an employee benefit. Handr block It includes amounts paid for unused vacation leave. Handr block You can deduct vacation pay only in the tax year in which the employee actually receives it. Handr block This rule applies regardless of whether you use the cash or accrual method of accounting. Handr block Prev  Up  Next   Home   More Online Publications
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The Handr Block

Handr block 3. Handr block   Lifetime Learning Credit Table of Contents Introduction Can You Claim the CreditWho Can Claim the Credit Who Cannot Claim the Credit What Expenses QualifyQualified Education Expenses No Double Benefit Allowed Expenses That Do Not Qualify Who Is an Eligible Student Who Can Claim a Dependent's Expenses Figuring the CreditEffect of the Amount of Your Income on the Amount of Your Credit Claiming the Credit Introduction For 2013, there are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. Handr block They are the American opportunity credit and the lifetime learning credit. Handr block This chapter discusses the lifetime learning credit. Handr block The American opportunity credit is discussed in chapter 2, The American Opportunity Credit . Handr block This chapter explains: Who can claim the lifetime learning credit, What expenses qualify for the credit, Who is an eligible student, Who can claim a dependent's expenses, How to figure the credit, How to claim the credit, and When the credit must be repaid. Handr block What is the tax benefit of the lifetime learning credit. Handr block   For the tax year, you may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all eligible students. Handr block There is no limit on the number of years the lifetime learning credit can be claimed for each student. Handr block   A tax credit reduces the amount of income tax you may have to pay. Handr block Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. Handr block The lifetime learning credit is a nonrefundable credit. Handr block This means that it can reduce your tax to zero, but if the credit is more than your tax the excess will not be refunded to you. Handr block   Your allowable lifetime learning credit may be limited by the amount of your income and the amount of your tax. Handr block Can you claim more than one education credit this year. Handr block   For each student, you can elect for any year only one of the credits. Handr block For example, if you elect to take the lifetime learning credit for a child on your 2013 tax return, you cannot, for that same child, also claim the American opportunity credit for 2013. Handr block   If you are eligible to claim the lifetime learning credit and you are also eligible to claim the American opportunity credit for the same student in the same year, you can choose to claim either credit, but not both. Handr block   If you pay qualified education expenses for more than one student in the same year, you can choose to take certain credits on a per-student, per-year basis. Handr block This means that, for example, you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year. Handr block Differences between the American opportunity and lifetime learning credits. Handr block   There are several differences between these two credits. Handr block For example, you can claim the American opportunity credit for the same student for no more than 4 tax years, but any year in which the Hope Scholarship Credit was claimed counts toward the 4 years. Handr block However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. Handr block The differences between these credits are shown in Appendix B, Highlights of Education Tax Benefits for Tax Year 2013 near the end of this publication. Handr block Overview of the lifetime learning credit. Handr block   See Table 3-1, Overview of the Lifetime Learning Credit for the basics of the lifetime learning credit. Handr block The details are discussed in this chapter. Handr block Can You Claim the Credit The following rules will help you determine if you are eligible to claim the lifetime learning credit on your tax return. Handr block Who Can Claim the Credit Generally, you can claim the lifetime learning credit if all three of the following requirements are met. Handr block You pay qualified education expenses of higher education. Handr block You pay the education expenses for an eligible student. Handr block The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Handr block Table 3-1. Handr block Overview of the Lifetime Learning Credit Maximum credit Up to $2,000 credit per return Limit on modified adjusted gross income (MAGI) $127,000 if married filling jointly;  $63,000 if single, head of household, or qualifying widow(er) Refundable or nonrefundable Nonrefundable—credit limited to the amount of tax you must pay on your taxable income Number of years of postsecondary education Available for all years of postsecondary education and for courses to acquire or improve job skills Number of tax years credit available Available for an unlimited number of years Type of program required Student does not need to be pursuing a program leading to a degree or other recognized education credential Number of courses Available for one or more courses Felony drug conviction Felony drug convictions do not make the student ineligible Qualified expenses Tuition and fees required for enrollment or attendance (including amounts required to be paid to the institution for course-related books, supplies, and equipment) Payments for academic periods Payments made in 2013 for academic periods beginning in 2013 or beginning in the first 3 months of 2014 Note. Handr block Qualified education expenses paid by a dependent for whom you claim an exemption, or by a third party for that dependent, are considered paid by you. Handr block “Qualified education expenses” are defined later under Qualified Education Expenses . Handr block “Eligible students” are defined later under Who Is an Eligible Student . Handr block A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's Expenses . Handr block You may find Figure 3-1, Can You Claim the Lifetime Learning Credit for 2013 , later, helpful in determining if you can claim a lifetime learning credit on your tax return. Handr block Who Cannot Claim the Credit You cannot claim the lifetime learning credit for 2013 if any of the following apply. Handr block Your filing status is married filing separately. Handr block You are listed as a dependent on another person's tax return (such as your parents'). Handr block See Who Can Claim a Dependent's Expenses , later. Handr block Your modified adjusted gross income (MAGI) is $63,000 or more ($127,000 or more in the case of a joint return). Handr block MAGI is explained later under Effect of the Amount of Your Income on the Amount of Your Credit . Handr block You (or your spouse) were a nonresident alien for any part of 2013 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. Handr block More information on nonresident aliens can be found in Publication 519. Handr block You claim the American Opportunity Credit (see chapter 2) or a Tuition and Fees Deduction (see chapter 6) for the same student in 2013. Handr block What Expenses Qualify The lifetime learning credit is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Handr block Generally, the credit is allowed for qualified education expenses paid in 2013 for an academic period beginning in 2013 or in the first 3 months of 2014. Handr block For example, if you paid $1,500 in December 2013 for qualified tuition for the spring 2014 semester beginning in January 2014, you may be able to use that $1,500 in figuring your 2013 credit. Handr block Academic period. Handr block   An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. Handr block In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period. Handr block Paid with borrowed funds. Handr block   You can claim a lifetime learning credit for qualified education expenses paid with the proceeds of a loan. Handr block You use the expenses to figure the lifetime learning credit for the year in which the expenses are paid, not the year in which the loan is repaid. Handr block Treat loan disbursements sent directly to the educational institution as paid on the date the institution credits the student's account. Handr block Student withdraws from class(es). Handr block   You can claim a lifetime learning credit for qualified education expenses not refunded when a student withdraws. Handr block Qualified Education Expenses For purposes of the lifetime learning credit, qualified education expenses are tuition and certain related expenses required for enrollment in a course at an eligible educational institution. Handr block The course must be either part of a postsecondary degree program or taken by the student to acquire or improve job skills. Handr block Eligible educational institution. Handr block   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. Handr block S. Handr block Department of Education. Handr block It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. Handr block The educational institution should be able to tell you if it is an eligible educational institution. Handr block   Certain educational institutions located outside the United States also participate in the U. Handr block S. Handr block Department of Education's Federal Student Aid (FSA) programs. Handr block Related expenses. Handr block   Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution for enrollment or attendance. Handr block Prepaid expenses. Handr block   Qualified education expenses paid in 2013 for an academic period that begins in the first three months of 2014 can be used in figuring an education credit for 2013 only. Handr block See Academic period , earlier. Handr block For example, you pay $2,000 in December 2013 for qualified tuition for the 2014 winter quarter that begins in January 2014, you can use that $2,000 in figuring an education credit for 2013 only (if you meet all the other requirements). Handr block You cannot use any amount you paid in 2012 or 2014 to figure the qualified education expenses you use to figure your 2013 education credit(s). Handr block In the following examples, assume that each student is an eligible student at an eligible educational institution. Handr block Example 1. Handr block   Jackson is a sophomore in University V's degree program in dentistry. Handr block This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. Handr block Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified expense. Handr block Example 2. Handr block   Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. Handr block The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. Handr block Charles bought his books from a friend, so what he paid for them is not a qualified education expense. Handr block Donna bought hers at College W's bookstore. Handr block Although Donna paid College W directly for her first-year books and materials, her payment is not a qualified expense because the books and materials are not required to be purchased from College W for enrollment or attendance at the institution. Handr block Example 3. Handr block   When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. Handr block This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and student government. Handr block No portion of the fee covers personal expenses. Handr block Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. Handr block Therefore, it is a qualified expense. Handr block No Double Benefit Allowed You cannot do any of the following: Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim a lifetime learning credit based on those same expenses. Handr block Claim a lifetime learning credit in the same year that you are claiming a tuition and fees deduction for the same student. Handr block Claim a lifetime learning credit and an American opportunity credit based on the same qualified education expenses. Handr block Claim a lifetime learning credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP). Handr block See Coordination With American Opportunity and Lifetime Learning Credits in chapter 7, Coverdell Education Savings Account, and Coordination With American Opportunity and Lifetime Learning Credits in chapter 8, Qualified Tuition Program. Handr block Claim a credit based on qualified education expenses paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer. Handr block See Adjustments to Qualified Education Expenses, next. Handr block This image is too large to be displayed in the current screen. Handr block Please click the link to view the image. Handr block Figure 3-1 Adjustments to Qualified Education Expenses For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. Handr block The result is the amount of adjusted qualified education expenses for each student. Handr block Tax-free educational assistance. Handr block   For tax-free educational assistance received in 2013, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. Handr block See Academic period , earlier. Handr block   Some tax-free educational assistance received after 2013 may be treated as a refund of qualified education expenses paid in 2013. Handr block This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2013 for qualified education expenses paid on behalf of a student in 2013 (or attributable to enrollment at an eligible educational institution during 2013). Handr block   If this tax-free educational assistance is received after 2013 but before you file your 2013 income tax return, see Refunds received after 2013 but before your income tax return is filed , later. Handr block If this tax-free educational assistance is received after 2013 and after you file your 2013 income tax return, see Refunds received after 2013 and after your income tax return is filed , later. Handr block   Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. Handr block Generally, any scholarship or fellowship is treated as tax free. Handr block However, a scholarship or fellowship is not treated as tax free to the extent the student includes it in gross income (if the student is required to file a tax return for the year the scholarship or fellowship is received) and either of the following is true. Handr block The scholarship or fellowship (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. Handr block The scholarship or fellowship (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. Handr block You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. Handr block For examples, see Coordination with Pell grants and other scholarships, later. Handr block Refunds. Handr block   A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Handr block Some tax-free educational assistance received after 2013 may be treated as a refund. Handr block See Tax-free educational assistance , earlier. Handr block Refunds received in 2013. Handr block   For each student, figure the adjusted qualified education expenses for 2013 by adding all the qualified education expenses for 2013 and subtracting any refunds of those expenses received from the eligible educational institution during 2013. Handr block Refunds received after 2013 but before your income tax return is filed. Handr block   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid before you file an income tax return for 2013, the amount of qualified education expenses for 2013 is reduced by the amount of the refund. Handr block Refunds received after 2013 and after your income tax return is filed. Handr block   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid after you file an income tax return for 2013, you may need to repay some or all of the credit. Handr block See Credit recapture, next. Handr block Credit recapture. Handr block    If any tax-free educational assistance for the qualified education expenses paid in 2013 or any refund of your qualified education expenses paid in 2013 is received after you file your 2013 income tax return, you must recapture (repay) any excess credit. Handr block You do this by refiguring the amount of your adjusted qualified education expenses for 2013 by reducing the expenses by the amount of the refund or tax-free educational assistance. Handr block You then refigure your education credit(s) for 2013 and figure the amount by which your 2013 tax liability would have increased if you had claimed the refigured credit(s). Handr block Include that amount as an additional tax for the year the refund or tax-free assistance was received. Handr block Example. Handr block   You pay $9,300 in tuition and fees in December 2013, and your child began college in January 2014. Handr block You filed your 2013 tax return on February 14, 2014, and claimed a lifetime learning credit of $1,860. Handr block You claimed no other tax credits. Handr block After you filed your return, your child withdrew from two courses and you received a refund of $2,900. Handr block You must refigure your 2013 lifetime learning credit using $6,400 of qualified education expenses instead of $9,300. Handr block The refigured credit is $1,280 and your tax liability increased by $580. Handr block See instructions for your 2014 income tax return to determine where to include this tax. Handr block If you pay qualified education expenses in 2014 for an academic period that begins in the first 3 months of 2014 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified education expenses for 2014 instead of reducing your expenses for 2013. Handr block Amounts that do not reduce qualified education expenses. Handr block   Do not reduce qualified education expenses by amounts paid with funds the student receives as: Payment for services, such as wages, A loan, A gift, An inheritance, or A withdrawal from the student's personal savings. Handr block   Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following situations. Handr block The use of the money is restricted, by the terms of the scholarship or fellowship, to costs of attendance (such as room and board) other than qualified education expenses, as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. Handr block The use of the money is not restricted. Handr block For examples, see Adjustments to Qualified Education Expenses in chapter 2, American Opportunity Credit. Handr block Coordination with Pell grants and other scholarships. Handr block   In some cases, you may be able to reduce your tax liability by including scholarships in income. Handr block If you are claiming an education credit for a claimed dependent who received a scholarship, you may be able to reduce your tax liability if the student includes the scholarship in income. Handr block The scholarship must be one that may (by its terms) be applied to expenses (such as room and board) other than qualified education expenses. Handr block Example 1—No scholarship. Handr block Judy Green, who is unmarried, is taking courses at a public community college to be recertified to teach in public schools. Handr block Her AGI and her MAGI, for purposes of the credit, are $27,000. Handr block Judy takes the standard deduction of $5,950 and personal exemption of $3,800, reducing her AGI to taxable income of $17,250 and her tax before credits is $2,156. Handr block She claims no credits other than the lifetime learning credit. Handr block In July 2013 she paid $700 for the summer 2013 semester; in August 2013 she paid $1,900 for the fall 2013 semester; and in December 2013 she paid another $1,900 for the spring semester beginning in January 2014. Handr block Judy and the college meet all requirements for the lifetime learning tax credit. Handr block She can use all of the $4,500 tuition she paid in 2013 when figuring her 2013 lifetime learning credit. Handr block She claims a $900 lifetime learning credit and her tax after credits is $1,256. Handr block Example 2—Scholarship excluded from income. Handr block The facts are the same as in Example 1—No scholarship, except that Judy was awarded a $1,500 scholarship. Handr block Under the terms of her scholarship, it may be used to pay any educational expenses, including room and board. Handr block If Judy excludes the scholarship from income, she will be deemed (for purposes of computing her education credit) as having used the scholarship to pay for tuition, required fees, and course materials. Handr block Only $3,000 of the $4,500 tuition she paid in 2013 could be used when figuring her 2013 lifetime learning credit. Handr block Her lifetime learning credit would be reduced to $600 and her tax after credits would be $1,556. Handr block Example 3—Scholarship included in income. Handr block The facts are the same as in Example 2—Scholarship excluded from income. Handr block If, unlike Example 2, Judy includes the $1,500 scholarship in income, she will be deemed to have used the entire scholarship to pay for room and board. Handr block Judy's AGI will increase to $28,500, her taxable income would be $18,750, and her tax before credits would be $2,381. Handr block She would be able to use the $4,500 of adjusted qualified education expenses to figure her credit. Handr block Judy could claim a $900 lifetime learning credit and her tax after credits would be $1,481. Handr block Expenses That Do Not Qualify Qualified education expenses do not include amounts paid for: Insurance, Medical expenses (including student health fees), Room and board, Transportation, or Similar personal, living, or family expenses. Handr block This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. Handr block Sports, games, hobbies, and noncredit courses. Handr block   Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. Handr block However, if the course of instruction or other education is part of the student's degree program or is taken by the student to acquire or improve job skills, these expenses can qualify. Handr block Comprehensive or bundled fees. Handr block   Some eligible educational institutions combine all of their fees for an academic period into one amount. Handr block If you do not receive or do not have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. Handr block The institution is required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T. Handr block See Figuring the Credit , later, for more information about Form 1098-T. Handr block Who Is an Eligible Student For purposes of the lifetime learning credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution (as defined under Qualified Education Expenses , earlier). Handr block Who Can Claim a Dependent's Expenses If there are qualified education expenses for your dependent during a tax year, either you or your dependent, but not both of you, can claim a lifetime learning credit for your dependent's expenses for that year. Handr block For you to claim a lifetime learning credit for your dependent's expenses, you must also claim an exemption for your dependent. Handr block You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c. Handr block IF you. Handr block . Handr block . Handr block THEN only. Handr block . Handr block . Handr block claim an exemption on your tax return for a dependent who is an eligible student you can claim the lifetime learning credit based on that dependent's expenses. Handr block The dependent cannot claim the credit. Handr block do not claim an exemption on your tax return for a dependent who is an eligible student (even if entitled to the exemption) the dependent can claim the lifetime learning credit. Handr block You cannot claim the credit based on this dependent's expenses. Handr block Expenses paid by dependent. Handr block   If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid (or deemed paid) by your dependent as if you had paid them. Handr block Include these expenses when figuring the amount of your lifetime learning credit. Handr block    Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent. Handr block Expenses paid by you. Handr block   If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the lifetime learning credit. Handr block If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the lifetime learning credit. Handr block Expenses paid by others. Handr block   Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. Handr block In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. Handr block If you claim an exemption on your tax return for the student, you are considered to have paid the expenses. Handr block Example. Handr block In 2013, Ms. Handr block Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. Handr block For purposes of claiming a lifetime learning credit, Todd is treated as receiving the money from his grandmother and, in turn, paying his qualified education expenses himself. Handr block Unless an exemption for Todd is claimed on someone else's 2013 tax return, only Todd can use the payment to claim a lifetime learning credit. Handr block If anyone, such as Todd's parents, claims an exemption for Todd on his or her 2013 tax return, whoever claims the exemption may be able to use the expenses to claim a lifetime learning credit. Handr block If anyone else claims an exemption for Todd, Todd cannot claim a lifetime learning credit. Handr block Tuition reduction. Handr block   When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. Handr block If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. Handr block For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. Handr block Figuring the Credit The amount of the lifetime learning credit is 20% of the first $10,000 of qualified education expenses you paid for all eligible students. Handr block The maximum amount of lifetime learning credit you can claim for 2013 is $2,000 (20% × $10,000). Handr block However, that amount may be reduced based on your MAGI. Handr block See Effect of the Amount of Your Income on the Amount of Your Credit , later. Handr block Example. Handr block Bruce and Toni Harper are married and file a joint tax return. Handr block For 2013, their MAGI is $75,000. Handr block Toni is attending a local college (an eligible educational institution) to earn credits toward a degree in nursing. Handr block She already has a bachelor's degree in history and wants to become a nurse. Handr block In August 2013, Toni paid $5,000 of qualified education expenses for her fall 2013 semester. Handr block Bruce and Toni can claim a $1,000 (20% × $5,000) lifetime learning credit on their 2013 joint tax return. Handr block Form 1098-T. Handr block   To help you figure your lifetime learning credit, the student should receive Form 1098-T. Handr block Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2014. Handr block An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. Handr block However, the amounts in boxes 1 and 2 of Form 1098-T might be different from what you paid. Handr block When figuring the credit, use only the amounts you paid or are deemed to have paid in 2013 for qualified education expenses. Handr block   In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student. Handr block    The eligible educational institution may ask for a completed Form W-9S, or similar statement to obtain the student's name, address, and taxpayer identification number. Handr block Effect of the Amount of Your Income on the Amount of Your Credit The amount of your lifetime learning credit is phased out (gradually reduced) if your MAGI is between $53,000 and $63,000 ($107,000 and $127,000 if you file a joint return). Handr block You cannot claim a lifetime learning credit if your MAGI is $63,000 or more ($127,000 or more if you file a joint return). Handr block Modified adjusted gross income (MAGI). Handr block   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. Handr block MAGI when using Form 1040A. Handr block   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. Handr block MAGI when using Form 1040. Handr block   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. Handr block You can use Worksheet 3-1 to figure your MAGI. Handr block Worksheet 3-1. Handr block MAGI for the Lifetime Learning Credit 1. Handr block Enter your adjusted gross income  (Form 1040, line 38)   1. Handr block   2. Handr block Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. Handr block       3. Handr block Enter your foreign housing deduction (Form 2555, line 50)   3. Handr block       4. Handr block Enter the amount of income from Puerto Rico you are excluding   4. Handr block       5. Handr block Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. Handr block       6. Handr block Add the amounts on lines 2, 3, 4, and 5   6. Handr block   7. Handr block Add the amounts on lines 1 and 6. Handr block  This is your modified adjusted  gross income. Handr block Enter this amount  on Form 8863, line 14   7. Handr block   Phaseout. Handr block   If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 10-18 of Form 8863. Handr block The same method is shown in the following example. Handr block Example. Handr block You are filing a joint return with a MAGI of $112,000. Handr block In 2013, you paid $6,600 of qualified education expenses. Handr block You figure the tentative lifetime learning credit (20% of the first $10,000 of qualified education expenses you paid for all eligible students). Handr block The result is a $1,320 (20% x $6,600) tentative credit. Handr block Because your MAGI is within the range of incomes where the credit must be reduced, you must multiply your tentative credit ($1,320) by a fraction. Handr block The numerator of the fraction is $127,000 (the upper limit for those filing a joint return) minus your MAGI. Handr block The denominator is $20,000, the range of incomes for the phaseout ($107,000 to $127,000). Handr block The result is the amount of your phased out (reduced) lifetime learning credit ($990). Handr block   $1,320 × $127,000 − $112,000  $20,000 = $990   Claiming the Credit You claim the lifetime learning credit by completing Form 8863 and submitting it with your Form 1040 or 1040A. Handr block Enter the credit on Form 1040, line 49, or Form 1040A, line 31. Handr block Note. Handr block In Appendix A, Illustrated Example of Education Credits at the end of this publication, there is an example illustrating the use of Form 8863 when both the American opportunity credit and the lifetime learning credit are claimed on the same tax return. Handr block Prev  Up  Next   Home   More Online Publications