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The CORRECT way to Calculate Education Tax Credits | 1098-T Explained - YouTube
Channel: The Bemused: Making Sense of Money š°
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So I have some bad news for you guys.
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If you have been taking advantage of education
tax credits such as the American Opportunity
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Tax Credit or the Lifetime Learning credit,
chances are you (or your tax preparer) have
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been calculating it all wrong.
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A few weeks ago, we posted a video on tax
deductions for college students and in the
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comments we got a lot of questions about the
1098-T and how you use the 1098-T to calculate
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your tax credit.
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So this video is a follow-up to that video.
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So, if you havenāt seen that video, go watch
that one first and come back to this one.
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Itās time to clear the air and learn how
this is supposed to go.
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So hereās how a lot of people think the
credit works.
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You put in the information from your 1098-T,
subtracting your reported scholarships and
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grants in box 5 from the amount listed in
either box 1 or box 2.
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That should give you the net amount of qualified
expenses for which you can claim either the
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American Opportunity Tax Credit and/or Lifetime
Learning Credit, right?
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WRONG.
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However, this is what a lot of tax preparers
do and likely what many individuals do when
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filing taxes for themselves.
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So, hereās the correct way.
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Your American Opportunity Tax Credit and/or
Lifetime Learning Credit are calculated on
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the Form 8863.
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And this is what it looks like.
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Now, in the instructions for the 8863, the
IRS makes something very clear.
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Generally, qualified education expenses are
amounts paid in 2018 for tuition and fees
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required for the student's enrollment or attendance
at an eligible educational institution.
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It doesn't matter whether the expenses were
paid in cash, by check, by credit or debit
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card, or with borrowed funds.
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The amount of qualified tuition and related
expenses reported on Form 1098-T may not reflect
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the total amount of the qualified tuition
and related expenses paid during the year
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for which you may claim an education tax credit.
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You may include qualified tuition and related
expenses that are not reported on Form 1098-T
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when claiming one of these education benefits
if you can substantiate payment of these expenses.
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You may not include expenses paid on the 1098-T
that have been paid by qualified scholarships,
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including those that were not processed by
the universities.
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You may receive Form 1098-T from the institution
reporting payments received in 2018 (box 1).
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However, the amount in box 1 of Form 1098-T
may be different from the amount you paid
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(or are treated as having paid).
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In completing Form 8863, use only the amounts
you actually paid (plus any amounts you're
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treated as having paid) in 2018 (reduced,
as necessary, as described under Adjusted
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Qualified Education Expenses, later).
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See chapters 2 and 3 of Pub. 970 for more
information on Form
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1098-T.
When doing your taxes, your tax preparation
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software will often require you to replicate
what is reported on Form 1098-T by filling
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in boxes 1 or 2 and 5 at a minimum.
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Essentially,
Box 1 reports the amounts actually paid and
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Box 2 reports the amounts billed.
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Unfortunately, prior
to 2018 the majority of schools used the amounts
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billed method and would fill out Box 2 instead
of
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Box 1, which would not accurately reflect
when qualified expenses were actually paid,
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which is
what the education tax deductions and credits
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require to make sure the amounts used are
appropriate for each respective tax year.
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This was a big problem because many people
who have
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received the Form 1098-T with Box 2 instead
of Box 1 filled out have likely experienced
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something called āexpense lumpingā and
not to their benefit (combining fall semester
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tuition with spring semester tuition from
the following tax year).
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Let me explain.
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For example, if you look back to the financial
aid timeline, students who are enrolled in
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undergraduate study for four academic years
will be in college for five tax years and
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should
therefore, receive five Form 1098-Ts.
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However, institutions that use the billing
method will often
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lump the spring and fall semester tuition
and qualified expenses figures together starting
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in the fall
semester of freshman year.
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While this will not produce any significant
changes for the second and
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third years the Form 1098-T form is received,
it is likely that the first year will overreport
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expenses
that the student will not need to use all
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of since they only need $4,000 to get the
maximum
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American Opportunity Tax Credit and the student
may not receive a Form 1098-T in the fifth
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year or
will receive one with an amount reported in
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box 5 for scholarships and nothing reported
in Boxes 1
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or 2, which is exactly what happened to me
on my 1098-T this year.
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If the Form 1098-T information is reported
with nothing in Boxes 1 or 2 and an amount
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in Box 5, the
tax preparation software is likely to consider
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this scholarship taxable.
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The good news to this
problem is that starting in 2018, colleges
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and universities will be required to report
the amounts
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actually paid
instead of billed.
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So hereās the bottom line.
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When doing your taxes and seeking to claim
any education credits, it is best to not rely
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on only using Form 1098-T. Your tax preparer
should also request transaction history from
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the college, copies of bank/credit card statements,
and proof of loan disbursements, and to see
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what other expenses were incurred because,
remember, expenses related to other items
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such as the purchasing of books and supplies
will likely not be reported on the Form 1098-T.
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So, now that weāve hopefully cleared that
up, what are some things that you can do if
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you realize you or your tax preparer have
been doing this thing wrong?
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Well, if claiming the credits correctly would
have put you (or your parents) in a more favorable
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tax position, you always have the option of
amending your tax return up to three years
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from the date on which you filed.
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You also have a very powerful option when
claiming education credits that not many people
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know about, so pay attention!
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You may be able to increase an education credit
and reduce your total tax or increase your
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tax refund if the student (you, your spouse,
or your dependent) chooses to include all
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or part of certain scholarships or fellowship
grants in income.
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The scholarship or fellowship grant must be
one that may qualify as a tax-free scholarship
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under the rules discussed in chapter 1 of
Pub. 970.
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Also, the scholarship or fellowship grant
must be one that may (by its terms) be used
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for expenses other than qualified education
expenses (such as room and board).
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The IRS even gives an example of this in the
instructions for the 8863.
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Letās say thereās a pretty typical scenario
of a parent and child.
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The student is in their first year of college
and they have little to no income of their
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own.
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They want to take advantage of the American
Opportunity Tax Credit this year.
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Assuming that the parent is eligible to take
the credit based on income, hereās what
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they can do.
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Example 1.
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Last year, your child graduated from high
school and enrolled in college for the fall
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semester.
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You and your child meet all other requirements
to claim the American opportunity credit,
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and you need to determine adjusted qualified
education expenses to figure the credit.
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Letās say tuition and fees were $5,000 and
room and board was $4,000.
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Your child received a $5,000 Pell grant and
took out a $2,750 student loan to pay these
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expenses.
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You paid the remaining $1,250.
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The Pell grant by its terms may be used for
any of these expenses.
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If you and your child choose to apply the
Pell grant to the qualified education expenses,
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it will qualify as a tax-free scholarship
under the rules discussed in chapter 1 of
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Pub. 970.
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Your child won't include any part of the Pell
grant in gross income.
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After reducing qualified education expenses
by the tax-free scholarship, you will have
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$0 ($5,000 ā $5,000) of adjusted qualified
education expenses available to figure your
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credit.
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Your credit will be $0.
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Example 2.
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The facts are the same as in Example 1 unlike
in Example 1, you and your child choose to
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apply only $1,000 of the Pell grant to the
qualified education expenses and to apply
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the remaining $4,000 to room and board, only
$1,000 will qualify as a tax-free scholarship.
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Your child will include the $4,000 applied
to room and board in gross income, and it
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will be treated as earned income for purposes
of determining whether your child is required
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to file a tax return.
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If the $4,000 is your childās only income,
your child won't be required to file a tax
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return.
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After reducing qualified education expenses
by the tax-free scholarship, you will have
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$4,000 ($5,000 ā $1,000) of adjusted qualified
education expenses available to figure your
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credit.
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Your refundable American opportunity credit
will be $1,000.
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Your nonrefundable credit may be as much as
$1,500, but depends on your tax liability.
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If you're not otherwise required to file a
tax return, you should file to get a refund
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of your $1,000 refundable credit, but your
tax liability and nonrefundable credit will
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be $0.
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For details and more examples, please please
please go see Pub. 970, which will be linked
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once again in the description box below.
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