The Hope credit and Lifetime Learning credit can provide significant tax savings for costs related to higher education. These tax tools are not deductions, but rather are tax credits that, for many taxpayers, will equate to actual dollars. These credits are nonrefundable. This means that if the credits are more than your tax, the excess is not refunded to you.

The credits are based on qualified tuition and related expenses you pay for yourself, for your spouse, or for a dependent for whom you claim an exemption on your tax return. If you claim an exemption for your child on your tax return, only you, (not your child) can claim a credit for the child. Furthermore, if you claim an exemption for your child, you may treat expenses paid by your child as if you had paid them. If you do not claim an exemption for your child on your tax return, only your child can claim the credit.

Generally, the credits are allowed for qualified tuition and related expenses paid for an academic period beginning in the same year as the year the payment is made. If, however, you pay qualified tuition and related expenses for an academic period that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit. This means that qualified tuition paid at the end of the year 2000 for a spring semester that begins in 2001 could, in some cases, still be used to generate a credit for the year 2000.

Generally, the Hope credit is available for the first two years of undergraduate education, while the Lifetime Learning credit is available for all undergraduate and graduate levels of education. For each student, you can elect for any tax year only one of the credits or a tax-free withdrawal from an education IRA. If you pay qualified expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. Thus, you can claim the Hope credit for one student and the Lifetime Learning credit for another student in the same tax year.

The Hope credit and the Lifetime Learning credit are phased out if the taxpayer's modified adjusted gross income is too high. The phaseout occurs when modified adjusted gross income is between $40,000 and $50,000 ($80,000 to $100,000 for joint returns). Therefore, if modified adjusted gross income is $50,000 or more ($100,000 or more for a joint return), then the higher education credits are not available. Also, if you are married and filing separately, then you cannot claim the higher education credits.

In general, qualified tuition and related expenses are tuition and fees required for enrollment or attendance at an eligible educational institution. Student activity fees and fees for course-related books, supplies, and equipment are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. Expenses that do not qualify include items such as insurance, medical expenses (including student health fees), room and board, transportation or similar personal living or family expenses, even if the fee must be paid to the institution as a condition of enrollment or attendance.

Qualified tuition and related 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. However, if the course of instruction or other education is part of the student's degree program or, in the case of the Lifetime Learning credit, is taken by the student to acquire or improve job skills, these expenses can qualify.

Qualified expenses are reduced if paid with certain tax-free funds such as scholarships, Pell grants, employer-provided educational assistance, and veterans' educational assistance. A scholarship reported as income on the student's return or any other scholarship which, by its terms, cannot be applied to qualified tuition and related expenses will not reduce qualified expenses.

An eligible education institution, such as a college or university, that receives payment for qualified tuition and related expenses generally must issue Form 1098-T, Tuition Payments Statement, to each student early in 2001. Make sure you bring this form to your tax preparer. If you don't receive the form, bring the school's bill and receipts to your tax professional.

Hope Credit. With respect to the Hope credit, an eligible student is a student who meets four requirements:

1. The student has not completed the first two years of post-secondary education (generally, freshman and sophomore years of college) as of the beginning of the year.
   
2. The student is enrolled in a program that leads to a degree, certificate, or other recognized educational credential for at least one academic period beginning during the year.
   
3. The student is taking at least half of the normal full-time work load for his or her course of study for at least one academic period during the calendar year.
   
4. The student is free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of the year.

The Hope credit consists of 100% of the first $1,000 of qualified tuition and related expenses you pay for each eligible student, plus 50% of the next $1,000 so paid. Thus, the maximum Hope credit is $1,500 times the number of eligible students. Remember, the credit is phased out if modified adjusted gross income is too high.

Lifetime Learning Credit. The amount of the Lifetime Learning credit is 20% of the first $5,000 of qualified tuition and related expenses you pay for all students in the family. The maximum amount of the Lifetime Learning credit is $1,000 ($5,000 x 20%). Again, the credit is phased out if the modified adjusted gross income is too high.

The Lifetime Learning credit is different from the Hope credit in other ways. For example, it's not based on the student's work load. In fact, the Lifetime Learning credit is allowed for one or more courses. It's not limited to students in the first 2 years of post-secondary education, and thus expenses for graduate-level degree work are eligible.