The CORRECT way to Calculate Education Tax Credits | 1098-T Explained


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

  1. Wow that was a lot of info. I just got off the phone with Tax Act and I'm very confused. Box 2 of my son's 2017 1098t included amounts billed for Spring 2018. His 2018 box 1 and 2 are empty. He has credits on his account from scholarships, grants and loans paid in 2018. Can we get credit for any of those? How? I'm so confused.Thanks so much!

  2. We got so many questions on the 1098-T from a previous video that we decided to make a follow-up video! We hope this gives you guys some more clarity but, if not, drop your questions in the comments below!

  3. I took your advice and went to my daughter's school and got her Ledger Card … which indicate the tuition fees for 2018 = $5125 and in Box 1 of 1098T = $3572 … can I use the Ledger amount of $5125 to calculate her education credit?

  4. I posted a question on your,last video but I’m going to post it here too.

    I heard AOTC hasn’t been approved by Congress for this year, has anyone else heard this?

  5. So I see the tuition and fees Form 8917 online shows an IRS message when you try to open it that it was not issued for 2018. We had used that form in 2017 for the tuition costs for our son, or rather our tax preparer did. This year we will use Form 8863 Education Credits for his tuition and book costs. Yes, the 1098-T form numbers were showing all the payments we made during 2018 on our sons college account billing statement, but I had to use the monthly paper statements they sent during the year to get the line item amounts for tuition and class fees only, then deduct all the scholarships I saw they applied on those same statements. That gave me the true final total of QUALIFIED education expenses (which we paid during 2018, and the statements show all our payments as well). So you have to dig for the numbers, you won't find what you're looking for on the 1098-T. I'm keeping copies of the college statements with my tax 2018 tax receipts file in case of audit.

  6. So just to be clear, I have a quick question:
    I returned to school in 11/2018 and have been enrolled at least half time and received my 1098T. It has a dollar amount in Box 1 (this is my first time taking out student loans, pursuing a bachelors degree; the amount is approx. $3,100). I put this amount where my tax filing program (Credit Karma) requested it. It really boosted my refund amount and now I am…nervous. I don’t want to get any negative auditing when I file and feel I may now need a preparer for this (this is my first time completing taxes on my own – I’m 26, independent student). I have not paid anything toward my loans AT ALL – how am I potentially getting such a refund back like this? It’s approximately $2,200 on top of my usual from my employment tax refund for federal.

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