Tax credits for college grow, cover more students

College students or their parents have a new opportunity to get a tax credit for college expenses.

Barbara Weltman, author of two J.K. Lasser tax guides, calls the American opportunity tax credit a "new and improved" version of the Hope credit.

The maximum annual credit - $2,500 - is bigger than what was available under the Hope credit and the income eligibility has been eased somewhat. Also, it's available to students for the first four years of post-secondary education; the Hope credit could be used only for the first two years. Students also must be enrolled at least half-time.

On top of that, 40 percent of the credit is refundable. "You get the credit back even if it's more than you owe," Weltman said.

Congress created the new, temporary credit as part of legislation designed to help the economy crawl out of a deep recession. It is available for both the 2009 and the 2010 tax years.

"This is the better credit to go for if you qualify," said Jeff Schnepper, MSN Money tax expert.

To claim the maximum credit, a student would have to spend $4,000 on qualifying expenses, including tuition and fees. Eligible expenses also include the cost of course materials, including books, something not allowed under the Hope credit.

The credit begins phasing out for individuals whose modified adjusted gross income is more than $80,000, or $160,000 for married couples filing jointly.

If you're not eligible for the American opportunity credit, there may be other options that have the effect of reducing the cost of going to college:

-Lifetime learning credit: Undergraduates in their fifth or sixth year of study, students attending school part-time and graduate students may be eligible for a lifetime learning credit of up to $2,000.

Similar to the American opportunity and Hope credits, the lifetime learning credit phases out for people with higher incomes. Taxpayers may not claim both the American opportunity and the lifetime learning credits for the same student in the same year.

-Tuition deduction: Also available to taxpayers is a deduction of up to $4,000 for eligible tuition and fees for higher education. The deduction is available both to people who itemize and those who claim the standard deduction, but there are income eligibility limits. You cannot claim the tuition and fees deduction for a student if you or anyone else claims an education tax credit for that student in the same year.

Unlike a credit, which reduces actual taxes owed, a deduction reduces the income on which your taxes are computed.

-Deduction for interest paid on student loans: A maximum $2,500 deduction can be taken for interest paid on student loans. To qualify, an individual's modified adjusted gross income must be less than $75,000. The income limit on a joint return is $150,000.

-Business deduction for work-related education: To qualify, the course or class must be required by your employer for your present job or related to it. You cannot deduct education expenses incurred to train for a new position. The cost of education related to your job would be included in the miscellaneous column of your itemized deductions. To take the deduction, the total of all miscellaneous deductions must exceed 2 percent of your adjusted gross income. Self-employed people may subtract the expense from their income.

Alternatively, workers and self-employed people who take courses to acquire or improve job skills may instead qualify for the lifetime learning credit.

In another change affecting parents and students for tax years 2009 and 2010, money may be withdrawn from a tax-free college savings or prepaid tuition plan to cover the cost of computers, educational software or internet access while a student is in college. Distributions under the so-called 529 plans are not taxed. Previously, the qualified expenses did not include computer equipment or internet access.