Two Tax Credits for College

Just when you thought the IRS was all about audits, penalties and taking your money, along comes the education tax credit to ruin the bad rep.  This tax credit gives you a break for taking college courses.  There are two types of education tax credits, one for getting your degree and one for taking job-related courses.  They are different in their limits, their tax credit amounts, and their qualifications.  A quick read of the differences between the two education tax credit programs will give you all you need to know about claiming the right credit for you.  But first let’s look at the similarities in the qualifications, and rule out whether you’re eligible to begin with.

You Can Claim the Education Tax Credit  if…

You can claim either one of the education tax credits if you file your own tax return rather than tagging along on someone else’s as a dependent.  What this means is, if you are claimed as a dependent on someone else’s tax return then that person would claim the education tax credit, not you.  What does this mean exactly?  Well usually the people who are claimed as a dependent on someone else’s tax return are children, or teenagers or even people in their early 20s.  Parents claim their children as dependents and get tax breaks.  Parents will sometimes continue to claim their grown children as dependents as long as it continues to be financially worth it.  This usually occurs when the parents are still supporting the grown children, say when they are in college or living at home with no job.

IRS Rules for Claiming Dependents

A dependent is your child who is under 19.  If this person is a full time student then you can still claim him or her up to age 24.  After that the IRS considers them thrown from the nest, even if they are still in school full time.  So, for the education tax credit you wish to claim, make sure your parents are not still claiming you if you’re 24 or younger.

Even if you’re 20 and going to school full time, your parents might not be able to claim you as a dependent if you have a job and pay for more than half of your living expenses.  Also, if you don’t live at home for more than half the year then your parents can’t claim you as a dependent.

The Two Types of Education Credits

Well if you’re still eligible after reading through the rules for claiming dependents then now you’re ready to choose your education tax credit.

  1. The American Opportunity Tax Credit.  This is for getting a four-year college degree.  You must be enrolled in a degree program at an accredited college.  If you have a drug felony in your background you can forget about the American Opportunity Education Credit.  Also, this credit is available for only four years, then it expires for you.
  2. The Lifetime Learning Tax Credit.  This is for taking college courses that may or may not be part of a degree program.  Usually this is meant to be applied to courses you take at the post-secondary level, that will help you with your career, or getting a job.  Unlike the American Opportunity tax credit, this one has no limit: you can claim it every year if your courses qualify.  Also, there is no felony drug conviction barrier with this education tax credit.

To claim either one of the education tax credits on your federal income tax return, use IRS Form 8863, available on the IRS website here.


You Don’t Have to Live Abroad to Claim the Foreign Tax Credit

Don’t think the  foreign tax credit is for diplomats and ex-pats only.  You don’t have to live in a foreign country in order to be eligible for the  foreign tax credit.  How is the world can that be possible?  Well think about your investments: you may not live overseas but your money might be!  If you own a mutual fund that has holdings in a foreign company than you own stock in another country.  You may have paid tax on your earnings, to the government of the foreign country in which your stock’s company is located.

Why is There a Foreign Tax Credit?

Uncle Sam doesn’t want you to pay taxes twice on the same earnings so if you paid the foreign government then you don’t have to pay the IRS.  You would claim the  foreign tax credit, or in some cases a foreign tax deduction.  Usually a tax credit is more valuable than a tax deduction.  That’s because a credit reduces your bill like a coupon: get money taken off your total owed.  A deduction, on the other hand, reduces your taxable income.  The tax you owe the IRS is a percentage of your taxable income, so reducing your taxable income is nice but not as valuable as the credit.  A $100 deduction might be worth an extra $10 in your pocket whereas a $10 credit is worth exactly that: $10.

So…Why Would Anyone Take the Deduction Instead of the Credit?

Well sometimes the  foreign tax credit isn’t available.  Some taxes are only applicable to the deduction.  You can’t claim the credit for taxes paid on income from foreign oil investments.  I guess the government wants to encourage investment in domestic oil by discouraging investment in foreign oil.  You also can’t claim the  foreign tax credit on taxes of profits from international boycott operations.  Uncle Sam doesn’t want your money involved in international politics.  Another no-no is claiming the  foreign tax credit on profits on companies with which the USA doesn’t have diplomatic relations.  You can find the list of such “bad” countries with the Secretary of State.  These are countries involved in lots of terrorism or who have governments that we don’t recognize.

There are more and more types of foreign income on which the taxes may not be removed by the  foreign tax credit.  Therefore, try the foreign tax deduction and you might have some luck.

How Do I Claim the Foreign Tax Credit?

That depends on how much foreign tax you paid during the tax year.  If it’s under $300 then you can simply claim the  foreign tax credit under the Credits section of IRS Form 1040.  If it’s more than $300 then you must use IRS Form 1116, called Foreign Tax Credit (Individual, Estate or Trust).  


A Tax Credit for Going to College

If you’re going to college to make your life better then Uncle Sam wants to give you a reward.  It’s the IRS college tax credit, which comes in two forms.  One is the American Opportunity Tax Credit and the other is the Lifetime Learning tax credit.  The former is for getting a four-year college degree.  The latter is for job-related college courses that are taken but not as part of a degree program.

The American Opportunity College Tax Credit

The IRS will credit your tax bill and even refund up to 40% of your college tax credit for qualified payments you made.  The payments must be for tuition and required fees for a four year college degree.  The American Opportunity college tax credit is available only for the first four years of college, whether you need more time to finish your degree or not.   The student can be you or a dependent like your son or daughter or your spouse.  They have to be claimed as a dependent on your  federal income tax return.  Along with that return you’ll be filing IRS form 8863.

The courses have to be part of a four-year degree program and the student has to be enrolled in the program towards a degree and enrolled for at least one semester during the tax year.

The Lifetime Learning College Tax Credit

If you aren’t enrolled in a four year college working towards a degree but you take college courses, it may be worthwhile to look into the Lifetime Learning college tax credit.  This can be used all your life for when your college courses relate to your job or for a job you want.  It’s to encourage you to get better employment, basically.  For this college tax credit the rules are little less stringent.  For one, you can be a drug felon and still get this tax credit, unlike the American Opportunity credit.  For two, there’s no four-year limit (the American Opportunity is good for four years and then it’s over forever).  For another, you can just take a course but not enroll in a program for this college tax credit.

Rules for Both Types of College Tax Credits

Your “college” or post secondary educational institute must be accredited: no fly-by-night colleges allowed.  Secondly, the costs that these college tax credits cover are for tuition and necessary fees, NOT room and board or transportation or anything personal.

What is the R&D Tax Credit?

The R&D tax credit can usually be claimed if your business is involved in anything that requires an engineer.  This tax credit encourages invention of new products but it also can be applied to companies who spend money to improve production, make things faster or make things cleaner.  In other words, if you spend money on figuring out how to make an existing product better, that’s R&D and worth of the tax credit, in the eyes of the IRS.

Three Things to Know about the R&D Tax Credit

  1. You can claim this credit even if your company doesn’t have a laboratory with test tubes.  Did you hire an engineer to improve your software for managing your alarm systems that you sell?  Well that expense can be claimed under the R&D tax credit.  In this case you’re not even inventing anything, just making an existing product better.  If you developed a product or improved it using an experimental process, it’s R&D.
  2. Even if you don’t hire out for an engineer but instead use your own employees for the R&D, you can claim the R&D tax credit.  Just make sure that you can prove that at least 80% of that employee’s time was spent on R&D.  That will allow you to claim 100% of their time to claim the credit.
  3. If you are a small or medium business, you don’t have to worry that claiming the R&D tax credit will trigger an IRS audit.  Usually it’s the big companies with bigger R&D tax credits that get scrutinized.

The R&D Tax Credit: How it Works

The amount expenses you can claim is where lots of business owners get stymied.  Calculating your R&D tax credit works like this:

  1. Take the amount you’ve spent on R&D in the last three years and divide by 3 to get the average amount.
  2. Now take 50% of that number.  That dollar amount is your credit base.
  3. Now, any R&D money spend in the current tax year over that credit base will count towards your R&D tax credit.
  4. Take 14% of what you spent above and beyond your credit base: that’s the amount of your R&D tax credit for that year.



The Mortgage Interest Tax Deduction: Not What You Think!

Got it? Might as well use it.  The mortgage interest tax deduction, that is.  While it’s not going to change your life, it will save you a few hundred dollars on your tax bill, on average.  What, not what you were expecting?  Thought the mortgage interest tax deduction was going to spur you to wealth and forever financial security?  Think again.

Mortgage Interest Tax Deduction: the Real Story

In fact, most people believe the mortgage interest tax deduction is the Federal Government’s way of encouraging home ownership.  Nope!  Realtors may want you to believe the mortgage interest tax deduction is going to change your life (“go ahead and buy a house: you’ll get to claim the mortgage interest tax deduction!!”) but in reality this tax deduction has little nor absolutely no bearing whatsoever on people’s decisions on whether to buy a home.

If you make between $40,000 and $75,000, according to a study done by economists at the University of Pennsylvania,  you will save about $50 per month by claiming the mortgage interest deduction.  Wow, what a difference!  Good thing you took out that $200,000 loan!

Now, if you make a quarter of a million dollars a year you’ll save ten times that amount: $500 per month saved by claiming the mortgage interest tax deduction.  So now once again we have a tax code that favors the wealthy.

It’s for this reason that many people are in favor of getting rid of the mortgage interest tax deduction altogether.  Britain did in 2000.  There is almost no evidence that this tax deduction encourages people to buy homes.  I have bought three homes in my lifetime and not once did I even consider the mortgage interest tax deduction.  Not once!

Bigger Loan, Bigger Tax Deduction

The bigger loan you take, the more you get to deduct.  If anything, the mortgage interest tax deduction encourages people to borrow more than they should.  That’s why realtors love the mortgage interest tax deduction.  What’s more, the deduction is valid for home equity loans, too.  Take out a huge HELOC and deduct away, baby!

Perhaps the mortgage interest tax deduction even contributed to the real estate bubble and the financial crisis The mortgage interest tax deduction is figured into the price of homes, did you know that?  Yes, the prices of homes on the market are higher than they would be if there was no mortgage interest tax deduction.  Let me say that again.

the mortgage interest tax deduction makes home prices higher

So, for people who pay off their mortgage or who are financially responsible and borrow just what they can easily manage and pay off quickly, the mortgage interest tax deduction is not quite fair.

Home Ownership Not Affected by the Mortgage Interest Tax Deduction Because that’s Not What it was Originally Intended to do Anyway

The US income tax was first levied in its current form in 1913.  There were tax deductions, and one of them was interest.  Interest in general.  Interest was considered a business expense and mortgage interest just got lumped in with all the other types of interest, which were more business-related usually.  What!  Nope, contrary to popular belief the mortgage interest tax deduction is not Uncle Sam’s way of helping Americans buy a home.

in fact, the mortgage interest tax deduction costs Uncle Sam about $1 billion a year!  If the IRS had a mortgage interest tax credit instead of a deduction they would save lots of revenue.  This is actually a current proposal right now.  It would be more fair and it would bring in more money to the US Treasury.  Alan Viard, of the American Enterprise Institute, is a supporter of this idea, as is the Center on Budget and Policy Priorities.

So there you go folks: the mortgage interest tax deduction is not what it’s cracked up to be.  Don’t let realtors trick you into believing it’s going to save your finances when you take out too much loan to buy a home that’s too big for you.

The American Opportunity Tax Credit: A Teensy Bit of Help From Uncle Sam

Smart but not rich?  Then maybe you’re one of the few for whom a four-year college education might still be worth it.  Because going to college requires big money these days, some are considering whether a four year degree even makes any sense anymore unless you’re a truly serious student willing to study hard and make it all worth the money in the end.  The American Opportunity Tax Credit helps make this happen, one student at a time.

The American Opportunity Tax Credit

What the it does is basically give you money towards college, if you’re enrolled in the right kind.  It has to be an accredited postsecondary school and it has to participate in financial aid, the type administered by the US government, Department of Education.  You know: the Federal Financial Aid program.  I’m sure you’ve heard of it!

Now don’t get all excited about the prospect of having Uncle Sam pay your way through college.  There aren’t many free rides out there, other than full scholarships and if you ever got less than an ‘A’ in high school then you probably missed the boat on that one already!

What the American Opportunity Tax Credit does is reimburse you for up to $2000 of your college costs, then 25% of anything beyond that (which of course there’s lot of, seeing that college is way more expensive than $2000).  But the 25% of anything above $2000 goes only up to a limit of $500.  So, the most you can get from the American Opportunity Tax Credit will be a $2500 amount from the IRS.

What’s nice about the American Opportunity Tax Credit  is that it’s refundable.  A refundable tax credit means you can get that money subtracted off your tax bill even if you don’t have a tax bill.  The IRS will refund that amount to you.  So, if your tax bill is $0 before the American Opportunity Tax Credit, you’ll be getting up to $2500 in the form of an IRS refund.  Actually you’ll be getting more if you have an IRS refund for other reasons.  Just to be clear!

Qualifying for the American Opportunity Tax Credit

  1. Is your school accredited?  ask your school if you don’t know
  2. Does your school participate in Federal Financial Aid? Ask if you don’t know
  3. Are you working toward a degree or certificate?
  4. Were you enrolled for at least one semester during the year?
  5. Are you clear of federal or state felony drug charges?
  6. Are you claiming the American Opportunity Tax Credit for tuition?
  7. Are you claiming the American Opportunity Tax Credit  for related fees(required fees like student activity fees)?

If you can answer yes to all of these questions then you probably qualify.

The credit doesn’t cover…

  1. travel expenses (to school)
  2. noncredit courses
  3. hobby courses (knitting, tennis etc) unless it’s part of your degree
  4. room & board
  5. books
  6. supplies (unless required to be bought from your school)
  7. insurance & medical
  8. beauty & personal expenses, anything that’s personal

You can claim this credit four times in your lifetime so make it count!


The Student Loan Tax Deduction

There goes the IRS again…trying to help Americans improve their lives.  This time it’s the student loan tax deduction: encouraging us to to attend college, get loans, and deduct the interest on those loans.  Now don’t get me wrong: going to college can be a great thing.  And yes sometimes debt is necessary: in this case for the greater career goal you have in mind.  And yes, while every single tax deduction will help you in the end, this isn’t going to dramatically change your life.  The most deduction you can get is $2500 (that’s a deduction, not a credit so it’s not worth $2500 in your pocket). For more on student loan interest rates see the American Student Assistance website here.

How to Qualify for the Student Loan Tax Deduction

The IRS uses the term Qualified Education Loan, so let’s take a look at what constitutes “qualified”.

  1. First of all, your loan must be a loan that’s solely for eduction.  And it has to be higher education.  That means college.
  2. Secondly, the taxpayer must be the student, or the spouse of the student.  The student can also be a dependent of the taxpayer claiming the student loan tax deduction.
  3. Third, the time period of the loan must be around the same time frame as the actual education.  A “reasonable period of time” between the debt and the schooling must be shown.
  4. Fourth, the student must also be eligible.  Even if the student is eligible at the time of claiming the student loan tax deduction, it only counts if he or she was an eligible student at the time of the education.  Hope that makes sense.  In other words, maybe the taxpayer is claiming the deduction for interest paid on a loan taken out on his wife,  But if she wasn’t his wife at the time she was a student then he doesn’t get to claim the student loan tax deduction.
  5. Fifth, the expenses covered by the student loan must also be qualified.  This means the loan must cover the cost of attending school beyond what other financial help the taxpayer may have received.  In other words, the taxpayers expenses aren’t necessarily the same as what’s on the tuition bill.  He or she may have had some scholarships that cover education costs.  There are also some other education expenses that aren’t included in gross income on the 1040 anyway, so they can’t be covered by the student loan tax deduction.
  6. Sixth, the school has to qualify as well.  It must be an educational institution which has a program leading to a degree or a certificate.  It can be a college or it can be something like a hospital which offers post graduate education leading to some sort of certification.
  7. No double dipping.  If you are getting a deduction or credit for your student loan interest in some other way, it’s not allowed under this particular tax deduction.
  8. If you’re married, you have to file with the status married filing jointly in order to claim the student loan tax deduction.



If You Are Permanenty Disabled, This Tax Credit May Work for You

One of the reasons people are afraid to do their own taxes is they are afraid they’ll miss out on some deductions and credits.  It’s true, while there are a lot of prominent tax credits and deductions out there, there are even more lesser-known tax breaks to be claimed.

One of these is the disability tax credit.  If you are disabled you may qualify.  However, it’s not automatic and there are a few requirements you must meet in order to claim this tax credit.

How To Qualify for the Disability Tax Credit

  1. First of all you must be a U.S. citizen or a resident alien.  If you are the latter, then you probably know what that is.  But for the rest of you, a resident alien is a person who is  a permanent resident of the United States according to immigration law (you have a green card) and you must have been physically present in the US for a minimum amount of time.  For details, see the IRS website page on Resident Aliens here.
  2. Second, the disability tax credit is for people who are not yet of retirement age.  You must be under the age of 65 for the entire tax year for which you are claiming the credit.  You must also be younger than the mandatory retirement age set by your company.  This age will vary by company, of course.  Ask your employer.
  3. Third, you must be totally and permanently disabled.  This means you have a disability that prevents you from holding a job.  Plus, you must be retired or not working because of this disability.
  4. Fourth, your company must be paying disability income to you.  To get the disability tax credit, your payments must be coming from your employer’s health plan or pension plan or accident plan.
  5. You cannot have an income more than $17,500 if you are single.
  6. If you are receiving benefits that are not taxed, they cannot total more than $5000 for that tax year.  This figure is different depending on your filing status (single, married filing jointly, married filing separately).

How To Claim the Disability Tax Credit

Just use tax prep software is always the best answer!  But if you’re doing paper forms or want to check on what your tax prep guy is doing, it’s Schedule R.


How to Donate Your Old Car and Get a Tax Deduction

Time for a new car- well that can bring feelings of joy or dread.  It’s not cheap to purchase a car, even if it’s a used car.  But if you need to reduce your tax liability, there’s one bright light in the darkness ahead: the car donation tax deduction.  You can donate your old car to a qualified charity and deduct money on your tax return when you file for that year.

How it Works: The Car Donation Tax Deduction

  1. First of all, you have to make the donation to a qualified charity.  You cannot give your car to your cousin and get a tax deduction.  A qualified charity must have IRS approval.  The approval allows it to be tax-exempt and to receive charitable donations.
  2. Second of all, the car must be of use to someone- it can’t just be a junk heap.  But if the car is worth more than $500 it’ll count even if it’s not in good condition.
  3. third of all, the car donation tax deduction is only going to be worth something to you if you are itemizing your deductions anyway.  This goes on Schedule A, line 17.
  4. fourth, if the car you donated gets sold by the charity, your car donation tax deduction is that price it sold for.  if the charity sold it at a discounted price then use the fair market value of the car.  you can use the online version of Kelley Blue Book for that.
  5. If the car you donated was worth more than $500 then you’ll have to fill out IRS form 8283.
  6. If the car you donated was worth more than $5,000 you’ll also have to get a written appraisal to document the value.
  7. Make sure you get documentation of your car donation.  The qualified charitable organization where you donated it should give this to you and should include: your name, the  VIN of the car, date of donation, and whether you received any goods or services in return, if any.
  8. And last but not least, sometimes you have to pay in order to donate: appraisal fees are not deductible with the car donation tax deduction. They are, however, deductible under a different section on your tax return: under miscellaneous itemized deductions.

IRS Form 8283 Noncash Charitable Contributions

IRS Form 8283 is a form for reporting your charitable contributions like your car donation.  There’s a section called Donee Acknowledgement that’s kind of different: this is the part you get your charitable organization, the one that received the car donation, to fill out.  They must put the date of the car donation, whether they intend to use the car for something unrelated to the charity (the answer should be no!), their charity name, Employer ID, address, and an authorized signature and title of someone at the charity.



Adopting a Child is $$$$, Therefore the Adoption Tax Credit

Another family tax credit is the Adoption Tax Credit.  Adopting a child is very expensive- most people don’t have a clue as to how expensive it is to adopt a child.  Add that to the average cost of raising a child to the age of 17 (over $250,000) and we’re talking some serious money.   It costs somewhere around $25,000 to adopt a child, with some adoptions costing $40,000.  International adoptions are the most costly, not only because there are travel costs involved but because of the complexity.  Agencies to assist with adoptions charge way more for international adoptions.

Employer benefits and adoption loans and sometimes sliding scales can help with the cost and so can the Adoption Tax Credit. This federal tax credit cuts money from your tax bill to give you a break if you had some adoption costs during the tax year.  Even if the adoption doesn’t end up going through, you can still claim the adoption tax credit for the expenses you did incur in the process of trying.

If you adopt a child with special needs you don’t even have to have any expenses, you can probably get the adoption tax credit anyway.

What is the Adoption Credit?

The most you can get is $12,650 and it’s not refundable.  More on what that means later.  If your employer didn’t reimburse you for your adoption expenses (and why would they?  sheesh, must be nice to have that level of benefit these days), you can claim the adoption credit.  The adoption has to become final during the tax year on which you are claiming the tax credit, too.

The adoption credit was in danger of falling off the fiscal cliff at the end of 2012 but was saved at the last minute by Congress.  Only now it’s nonrefundable.  That means the credit is only worth anything to you if you owe money on your taxes.   But if you don’t owe the IRS any money after figuring and filing your federal income tax form, the adoption credit isn’t worth a dime…until next year.  It will reduce your tax bill, but it won’t result in a check from the IRS or a bigger tax refund.

About not being worth a dime until next year: here’s what I mean.  If you end up owing money on next year’s tax bill, you can apply your adoption tax credit to that bill.  If you still have no tax bill, then save the credit for the following year.  You can keep doing this for five years.  This is called carrying forward a tax credit.  One would say:

the Adoption Tax Credit can be carried forward for five years

How do I Claim the Adoption Credit?

Use IRS form 8839 to claim your qualified adoption expenses.  Find it on the IRS website here.  It’s got space enough to list expenses for three separate adopted children, should you be in such a situation.  There are special rules for foreign children.  If you got benefits from your employer that helped you out with your adoption expenses, these get listed in Part III on page two of the form.

If you make more than a certain amount then you won’t be eligible for the adoption tax credit.  your Modified Adjusted Income must be under $229,710.  For people making between  around $194, 000 and $234,000 the tax credit is worth less (this called a phase out, which happens to a lot of tax credits when income gets higher).

You don’t even need to keep receipts for your adoption expenses.  But keep the paperwork form when you calculated your adoption tax credit.

What are Qualified Adoption Expenses?

Well adoption fees are of course qualified expenses.  Also qualified are travel expenses directly related to the adoption, court fees, and your legal bill.  That’s about it, but those are some pretty heft costs.  For more information on what you can include in your claim on form 8839 see the IRS website’s page on Adoption Benefits and the Adoption Credit.