Higher Education Tax Credits and Deduction: An Overview of the Benefits and Their Relationship to Traditional Student Aid
Prepared for Members and Committees of Congress
The Taxpayer Relief Act of 1997 established two permanent federal income tax credits, effective
since tax year 1998, for qualified postsecondary education expenses: the Hope Scholarship credit
and the Lifetime Learning credit. The Economic Growth and Tax Relief Reconciliation Act of
2001 authorized a temporary income tax deduction for higher education expenses, which was
extended from December 31, 2005, to December 31, 2007, in the Tax Relief and Health Care Act
The Hope credit was introduced to help ensure that students have access to the first two years of
undergraduate education. The Lifetime Learning credit and tuition and fees deduction provide
support for students in any year of undergraduate and graduate study; they are unique in that they
are available to individuals taking occasional courses. Only one of the three tax benefits may be
taken in the same tax year for the same eligible student’s qualified expenses.
Key features of the education credits and deduction dictate who the provisions benefit and the
value of assistance they confer. Among these are the nonrefundable nature of the credits (i.e.,
persons must have income tax liabilities, which must exceed the maximum amount of the credits
to claim their full value), the deduction’s availability whether or not taxpayers take itemized
deductions, and the statutory limits on benefit amounts and on taxpayers’ income. Accordingly,
middle- and upper middle-income individuals are the targeted beneficiaries of these tax
All three benefits apply to the tuition and fees required for enrollment that are not offset by grant
aid (e.g., Pell Grants and scholarships) and other tax benefits (e.g., Coverdell Education Savings
Accounts and Section 529 Plans). The value of the Hope credit is a maximum of $1,650 per
student for tax year 2007; the Lifetime Learning credit, $2,000 per return since 2003. The value
of the deduction depends on taxpayers’ marginal tax rates, and it was available to persons higher
up the income scale than typically served by the credits. The deduction covers qualified expenses
of up to $4,000 per return in 2007, although a smaller deduction of up to $2,000 is available to
somewhat higher-income taxpayers.
With the introduction of these tax benefits, individuals can now receive substantial amounts of
federal financial assistance for postsecondary education from two parallel systems—the federal
income tax system and the traditional student aid delivery system, which provides aid such as
grants, loans, and work opportunities. The traditional system helps students meet current
expenses; the tax system requires families to make outlays that are reimbursed through tax
reductions determined near the end of or after an academic year. Tax benefits may offer
streamlined delivery of aid, while most other aid is delivered through relatively cumbersome and
labor-intensive processes. Some criticize the complexity of the tax process, however; and the
availability of the tax benefits adds another system that students and families must navigate and
learn to coordinate with any traditional aid received.
Introduc tion ..................................................................................................................................... 1
An Overview of the Benefits...........................................................................................................2
The Hope Scholarship Credit....................................................................................................2
The Lifetime Learning Credit...................................................................................................3
The Higher Education Deduction..............................................................................................4
Intended Beneficiaries and Benefit Size..........................................................................................7
Traditional and Nontraditional Students.............................................................................8
The Education Tax Benefits’ Relative Worth............................................................................9
Benefit Size and Tax Liability..........................................................................................10
Benefit Size and Qualified Expenses.................................................................................11
Relationship of Education Tax Benefits to the Traditional Student Aid Delivery System............12
Strengths and Weaknesses of the Approaches.........................................................................12
Direct Effect of Tax Benefits on Traditional Student Aid.......................................................13
Effect on Federal Student Aid...........................................................................................13
Effect on Packaging of Other Aid.....................................................................................14
Effect on State Decisions Related to Tuition Levels and Available Sources of Aid.........14
Table 1. Major Features of the Higher Education Tax Credits and Deduction................................5
Table 2. 2005 IRS Data for the Hope and Lifetime Learning Credits and the Higher
Table 3. Examples of Tax Savings from the Higher Education Tax Credits and Deduction.........10
Author Contact Information..........................................................................................................15
The Taxpayer Relief Act of 1997 (TRA, P.L. 105-34) established two permanent federal income
tax credits for qualified postsecondary education expenses: the Hope Scholarship credit and the
Lifetime Learning credit. They became available to taxpayers filing returns for 1998 and
thereafter. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L.
107-16) established a new temporary tax deduction for higher education expenses beginning in
At present, there are two parallel systems through which the federal government provides
assistance for postsecondary education attendance—namely, the traditional student aid delivery
system and the federal income tax system. The major Higher Education Act (HEA) Title IV
programs that provide federal aid are the Pell Grant program (an estimated $14 billion in grant aid
for FY2007) and the Federal Family Education Loan and Direct Loan programs (an estimated $64 2
billion in new loan volume for FY2007).
The value of the higher education credits and tuition deduction places them among the largest
sources of federal support to meet the costs of postsecondary education. Internal Revenue Service
(IRS) data show that taxpayers took $6.1 billion in education tax credits and $10.8 billion in
higher education deductions on their 2005 federal income tax returns.
There are important distinctions between the tax system as a mechanism for providing benefits
for postsecondary education expenses and the traditional student aid delivery system. Tax
incentives flow through a system that is dependent upon the tax status of filing units and the level
of qualified higher education expenses they incur. Tax benefits typically are not realized until
after, sometimes well after, education spending has occurred. Benefit calculations are independent
of any direct measurement of the ability to pay for postsecondary education. Further, the tax
incentives are not subject to annual appropriations. In contrast, federal assistance provided
through the traditional delivery system consists of grant, loan, and work aid. Much of this aid is
awarded directly to students, while some is controlled and disbursed by financial aid officers at
postsecondary institutions. A substantial portion of this assistance is awarded on the basis of 3
students’ financial need. Finally, a significant portion of this assistance is subject to annual
This report is intended to provide information about the direct assistance for education expenses
provided through the federal income tax system, thereby placing HEA student aid programs in a
broader context. The key features of these tax provisions—which largely dictate whom they assist
1 Information on legislative activity during the 110th Congress pertaining to the deduction and other education tax
benefits enhanced temporarily by EGTRRA is provided in CRS Report RS21870, Education Tax Benefits: Are They
Permanent or Temporary?, by Linda Levine.
2 A minority of new loan volume consists of federal funds; the majority is private capital supported by federal loan
guarantees and subsidies.
3 While still dominant, the portion of student aid that is being awarded dependent on need may be declining. As
reported by the Advisory Committee on Student Financial Assistance, “At the state level, new grant aid has shifted
steadily in favor of merit-based aid and against need-based aid.” (Access Denied: Restoring the Nation’s Commitment
to Equal Educational Opportunity, February 2001, p. 8.) The Committee reports that 18.6% of state grant aid funds is
and by how much—are explored. Further, it examines the relationship of the traditional student
aid delivery system with the tax system as a conduit for postsecondary education assistance.
The Hope Scholarship credit is a nonrefundable credit against federal income tax liability for 4
qualified higher education expenses. Initially, the credit for each eligible student was 100% of
the first $1,000 of qualified expenses and 50% of the second $1,000 of such expenses, for a
maximum benefit of $1,500. The $1,000 figures became indexed to inflation after 2001. The
formula specified in the TRA for this purpose resulted in the Hope credit’s maximum value rising
to $1,650 per student in tax year 2006 (i.e., 100% of the first $1,100 in qualified expenses and
Taxpayers can claim the credit for qualified higher education expenses of each eligible student for 5
whom they claim tax exemptions, including themselves, their spouse, and dependent children.
Eligible students must have been enrolled on at least a half-time basis for at least one academic
period during the tax year in a higher education program leading to a degree, certificate, or
credential. They cannot have finished the first two years of undergraduate education, and the 6
credit can only be claimed for their first two years of study. Individuals with a federal or state
felony conviction for drug possession or distribution are not eligible for the credit.
Qualified higher education expenses are defined as tuition and fees required for enrollment at
institutions eligible to participate in U.S. Department of Education (ED) student aid programs,
including accredited public, private, and proprietary postsecondary institutions. They include
those fees required as a condition for enrollment that are paid to the institution. Thus, fees for
course-related books, supplies, and equipment as well as activity fees are included only if they are
paid to the institution. Room and board, medical expenses including student health fees, and
transportation are among the costs excluded from coverage.
Qualified tuition and fees expenses must be reduced by the amount of non-taxable educational
assistance (exclusive of loans and gifts) that an eligible student receives. This includes education
assistance that is excluded from taxpayers’ gross income (e.g., Pell Grants, scholarships, veterans’
educational benefits, and employer-provided tuition reimbursements).
The amount of the Hope credit is gradually reduced for individuals whose modified adjusted 7
gross income for 2007 is between $47,000 and $57,000 (for those filing joint returns, between
4 Only individuals with income tax liability can benefit from a nonrefundable tax credit. A nonrefundable credit cannot
be worth more than the amount of the tax liability. In contrast, if the value of a refundable credit exceeds tax liability,
the federal government pays the taxpayer the amount of the difference between the two.
5 Expenses paid by a dependent or someone other than the filer, spouse, or dependent are treated as if paid by the
6 The first two years of postsecondary education can include two one-year certificate programs. See 67 Federal
Register 76687 (December 26, 2002), where the Hope and Lifetime Learning credits’ final regulations are published.
7 In general, taxpayers’ modified adjusted gross income equals their adjusted gross income (AGI). For taxpayers who
exclude income earned abroad or from certain U.S. territories or possessions, modified AGI is their AGI increased by
$94,000 and $114,000). A taxpayer having income above the eligibility ceiling with a student who
qualifies for the dependent exemption might decide not to make such a claim in the case of the
credit, thereby enabling the student to claim the credit’s full value if he/she has income below the
phase-out threshold and has income tax liability against which a credit could be taken. As
previously noted, the various income thresholds are indexed to inflation.
The Hope credit cannot be claimed for a student if the Lifetime Learning credit is claimed for the
same student in the same tax year. Individuals for whom a Hope credit is claimed cannot
concurrently benefit from the deduction for qualified higher education expenses taken for the
same student in the same tax year. For additional information on coordination of the Hope credit
with other postsecondary education tax benefits (e.g., Coverdell Education Savings Accounts and
Section 529 Programs) and for a comparison of the three education tax benefits that are the
subject of this report, see Table 1, below.
The Lifetime Learning credit also is a nonrefundable tax credit for qualified tuition and fees. For
qualified expenses paid on or after January 1, 2003, the credit per tax return is a maximum of
$2,000, calculated as 20% of the first $10,000 in qualified expenses. Unlike the Hope credit, the 8
value of the Lifetime Learning credit is not adjusted for inflation.
Also unlike the Hope credit, students eligible for the Lifetime Learning credit are those enrolled
in one or more courses of undergraduate or graduate instruction to acquire or improve job skills.
There is no limit on the number of years for which the Lifetime Learning credit may be claimed.
Like the Hope credit, the Lifetime Learning credit is available to individuals who pay the
qualified higher education expenses of eligible students for whom they claim exemptions on their
tax returns. Qualified tuition and related expenses are calculated and treated in the same fashion
as they are under the Hope credit, including the reduction for nontaxable educational assistance.
The Lifetime Learning and Hope credits share the same income-eligibility levels and income
The Lifetime Learning credit cannot be claimed for a student if the Hope credit is claimed for the
same student in the same tax year. Individuals for whom a Lifetime Learning credit is claimed
cannot concurrently benefit from the tax deduction for qualified higher education expenses. The
Lifetime Learning credit also coordinates with other education tax benefits in the same manner as
the Hope credit.
those excluded amounts.
8 The TRA had set the credit for tax years 1999-2002 at 20% of the first $5,000 of qualified expenses, or $1,000 at
The above-the-line deduction for taxpayers who pay qualified higher education expenses for 9
eligible students became effective in 2002. After expiring on January 1, 2006, it was reauthorized
retroactive to its expiration and to December 31, 2007.
The maximum deduction is $4,000 per return. This deduction is available to individuals with an
AGI of up to $65,000 ($130,000 in the case of filers of joint returns). There is a smaller deduction
of $2,000 for taxpayers whose AGI was more than $65,000 but not more than $80,000 (more than 10
$130,000 but not more than $160,000 for those filing joint returns). Neither the amount of the
deduction nor the income ceilings are adjusted for inflation. The amount of the deduction is not
gradually reduced by formula as the AGI of taxpayers rises within an income range.
Although the deduction reduces a taxpayer’s AGI dollar for dollar, it ultimately is worth different 11
amounts to taxpayers depending upon their marginal tax rates. For example, the deduction is
worth $450 in reduced tax liability to a taxpayer in the 15% tax bracket with $3,000 in qualified
expenses (0.15 x $3,000). For an individual in the 25% tax bracket with the same amount of
qualified expenses, the deduction produces a maximum of $750 in tax savings (0.25 x $3,000).
Taxpayers can take the deduction if they pay their own qualified higher education expenses or
those of their spouses or dependents for whom they claim tax exemptions. As with the Lifetime
Learning credit, there are no limitations on the level of postsecondary education enrollment
(undergraduate and graduate enrollment) or the intensity of enrollment (a single course of study,
half-time enrollment, or full-time enrollment). The qualified higher education expenses for the
deduction are defined as they are for the two credits.
The deduction cannot be taken for the qualified higher education expenses of any individual for
whom the Hope or Lifetime Learning credits are claimed. For the most part, qualified higher
education expenses are reduced by tax-free educational assistance and coordinated with other tax
benefits in the same fashion as they are for the credits. (See Table 1 for more detail.)
9 An above-the-line deduction is taken as an adjustment to taxpayer’s gross income on IRS 1040 form, and therefore
can be claimed whether or not the taxpayer itemizes deductions. A deduction affects the calculation of AGI. Unlike a
credit, it does not directly affect income tax liability.
10 Unlike the credits, if an eligible student qualifies as a dependent of his/her parents—regardless of whether the parents
take an exemption for their child—the parents can take the higher education deduction only if they actually pay the
qualified expenses. Even if the dependent student paid the qualified expenses, no one could claim the higher education
11 The marginal tax rate is the tax rate applied to the last additional dollar of income.
Table 1. Major Features of the Higher Education Tax Credits and Deduction
Characteristic Hope Scholarship Credit Lifetime Learning Credit Higher Education Deduction
Nature of the tax The credit reduces income tax liability. It is referred to as a Same The deduction reduces taxable income. It is referred to
benefit “nonrefundable credit” because it can only be claimed by as an “above-the-line” deduction because it is claimed
individuals who have tax liabilities remaining after they have as an adjustment to income on the 1040 form, and
taken personal/dependency exemptions, standard or therefore is available to taxpayers who do not itemize
itemized deductions, and other personal credits. As a deductions. The actual value of the deduction depends
result, the taxpayer may not be able to realize the full value on the taxpayer’s marginal tax rate. Generally, the
of the Hope Credit. higher the tax rate, the larger the deduction.
Who can claim it? Taxpayers who claim an exemption on their returns for a Same Same
student with qualified higher education expenses (e.g., a
child, a spouse, or themselves).
For whom can it be A student enrolled at least half-time for at least one A student enrolled in one or Same as Life Learning Credit
claimed? academic period in a program leading to an educational more courses at the
credential at an eligible educational institution, who is in their undergraduate level or graduate
first two years of postsecondary school and who has not had a level at an eligible educational
iki/CRS-RL31129felony drug conviction. The credit is available for two years institution who need not be
g/wper student. pursuing an educational
leakTuition and related expenses required for enrollment or Same Same Qualified expenses
attendance at an eligible educational institution.
://wikiThese expenses must be reduced by any tax-free Same Same
httpeducational assistance (e.g., Pell Grants, scholarships,
Veterans’ educational assistance, and employer-provided
Eligible institutions Any college, university, vocational school, or other Same Same
postsecondary institution eligible to participate in an ED-
administered student aid program.
Maximum value of $1,650 per student in tax year 2007. $2,000 per return in tax year $4,000 per return in tax year 2007.
the benefit (100% of the first $1,100 of qualified expenses and 50% of 2007.
the second $1,100 per student. Each of the dollar amounts is (20% of the first $10,000 of
indexed for inflation annually.) qualified expenses per return.)
Characteristic Hope Scholarship Credit Lifetime Learning Credit Higher Education Deduction
Income eligibility Taxpayers whose AGI is $57,000 or more ($114,000 or Same The $4,000 deduction is not available to taxpayers
limits more for those filing joint returns) are not eligible for the whose AGI is more than $65,000 (more than $130,000
credit in tax year 2007. The credit amount is gradually for those filing joint returns). Persons with AGIs of
reduced for taxpayers whose AGI is between $47,000 and more than $65,000 but not more than $80,000 (more
$57,000 ($94,000 and $114,000 for those filing joint than $130,000 but not more than $160,000 for joint
returns). The income ranges are adjusted annually for inflation. filers) are eligible for a lower maximum of $2,000.
There is no phase-out, and the income threshold is not
indexed for inflation.
The Hope Credit cannot be claimed if the Lifetime Learning Same Same Coordination of
Credit, Tuition and Fees Deduction, or business expense benefits (i.e., no
deduction is taken for the same student in the same year. double benefit
The Hope Credit cannot be claimed for the same qualified Same Same as Hope Credit except, with regard to QTPs, allowed)
expenses paid with tax-free educational assistance, with tax-the deduction could not be claimed for the same
free withdrawals from Coverdell Accounts and from qualified expenses paid with only the tax-free earnings
Section 529 Plans, and with tax-free interest on U.S. Savings portion of withdrawals.
iki/CRS-RL31129It can be claimed for qualified expenses paid with the Same Same
g/wproceeds of a loan.
s.orSource: The tax information was derived from IRS, Tax Benefits for Education, Publication 970; provisions of the Internal Revenue Code; and commentary.
Note: These education tax benefits cannot be claimed by married individuals who file separate returns. AGI refers to “modified AGI” (e.g., AGI plus foreign earned income
://wikiand housing exclusions), which are identical for most taxpayers.
Higher education tax incentives, like other forms of federal financial aid, represent investments in
human capital that are expected to yield benefits for society beyond those realized by individual 12
recipients. The tax benefits are not available to everyone seeking to meet postsecondary
education expenses; rather, they are primarily focused on specific groups of individuals and
provide them with different amounts of assistance.
The tax benefits were enacted to help preserve and enhance access to postsecondary education for
students from middle- and upper middle-income families. This group of families is not centrally
targeted by most other federal aid programs, which place primary emphasis on assisting students
with the greatest amount of financial need. Yet, students of middle-income families make up a
large proportion of the college population, and these families face the challenge of meeting costs
of higher education that have been increasing at a rate that has consistently outpaced inflation in
Table 2. 2005 IRS Data for the Hope and Lifetime Learning Credits and the Higher
Adjusted Gross Income
$15,000 $30,000 $50,000 $100,000
Under under under under under
All Returns $15,000 $30,000 $50,000 $100,000 $200,000
returns claiming 7,057,251 579,160 1,900,907 1,889,842 2,616,766 70,576
% of all returns 100% 8% 27% 27% 37% 1%
credits claimed $6,119,631 $187,931 $1,355,888 $1,703,978 $2,852,183 19,650
% of total 100% 3% 22% 28% 47% 0%
returns claiming 4,696,013 897,754 532,957 623,635 1,339,366 1,305,302
% of all returns
claiming 100% 19% 11% 13% 29% 28%
12 For additional information see CRS Report RL33238, The Benefits of Education, by Linda Levine.
Adjusted Gross Income
$15,000 $30,000 $50,000 $100,000
Under under under under under
All Returns $15,000 $30,000 $50,000 $100,000 $200,000
deduction $10,846,990 $2,326,300 $1,097,468 $1,326,369 $2,990,962 $3,105,890
claimed (in 000)
% of total 100% 21% 10% 12% 28% 29%
Source: IRS, Statistics of Income Division, July 2007.
Note: Sum of percentages may not equal 100% due to rounding. Data are not available for each credit
Available IRS data on tax benefit recipients indicate that the higher education tax credits and
deduction are, as intended, primarily serving middle- and upper middle-income individuals. As
shown above in Table 2, 38% of the 2005 tax returns that claimed the education credits were
from filers with an AGI of $50,000 or more, and 57% of the returns that claimed the deduction
were from filers in that AGI-range as well. These tax filers accounted for 47% of the total amount
claimed in these credits, and 57% in the deduction, for 2005.
Significantly, the Lifetime Learning credit and the deduction, which can be claimed for an
unlimited number of years, support traditional and nontraditional students regardless of their
enrollment or degree status. Part-time and full-time students can qualify, as can graduate,
undergraduate and non-degree students. As a consequence, the Lifetime Learning credit and the
deduction occupy a unique niche in the student aid landscape: the two tax incentives are widely
available benefits that can support students who are taking occasional courses but are not
necessarily enrolled in an educational credential or degree program. They may be a major source
of direct financial aid available to many individuals who want to take courses periodically over 13
the course of their careers to upgrade their skills.
Even though the Lifetime Learning credit and the deduction have been designed to provide aid to
a wide array of students, they likely will provide a good deal more benefit to traditional
undergraduate and graduate students on a per year basis than to sporadic course-takers. This is
due to the fact that the credit covers a maximum of $2,000 of eligible expenses incurred within a
year’s time, for example, and traditional students are likely to incur more costs. However,
sporadic course-takers can receive support for an unlimited number of years, and may ultimately
gain more value from the credit over a series of years than traditional students.
13 Among other more narrowly targeted benefits for individuals seeking to upgrade skills is employer education
Since many students are eligible for more than one of these benefits, taxpayers likely will attempt
to choose the one that provides the maximum value of tax savings to them. In general, when
examining the relative worth of the benefits, the following rules of thumb apply:
• For those middle-income taxpayers filing a joint return with one student who is
eligible for the Hope credit and with incomes below the phase-out range, the
Hope credit generally is more valuable than Lifetime Learning credit if qualified
expenses are less than $8,500. For families with more than one student eligible
for the Hope credit, the better choice for each child between the Hope credit and
the Lifetime Learning credit will depend upon the qualified expenses of the
• For those middle-income taxpayers filing a joint return with a student eligible to
receive either credit and with incomes below the phase-out range, the value of the
higher education deduction never exceeds that of the Hope credit and only
exceeds that of the Lifetime Learning credit when the amount of qualified
expenses is $4,000 or less and the taxpayer’s marginal tax rate is more than 20%.
• As income increases, the income thresholds at which the credits and deduction
are eliminated become increasingly important in determining who can receive
The figures in Table 3 can be used to illustrate some of these points. For a married-couple family
in the 15% tax bracket with one child eligible for the Hope credit who is attending a college at
which tuition and fees total $10,000 in a tax year, the Lifetime Learning credit is worth its
maximum of $2,000 in tax savings—higher than either the Hope credit maximum of $1,650
(which is reached when qualified expenses meet or exceed $2,200) or the deduction’s value of
$600 (0.15 x $4,000, the maximum amount of qualified tuition and fees that can be subtracted
from income). If the same family had a second child who also is eligible for the Hope credit and
who is attending a two-year public institution that charges tuition of $1,000, then the Hope credit
would be the better choice for the second child ($1,000) and the Lifetime Learning credit would
continue to be the better choice for the first child ($2,000); the total tax savings for the family
from the education credits would be $3,000. Other combinations of the credits, or of the credits
and the deduction, would produce a smaller tax savings for the family.
The importance of the amount of qualified expenses in determining the relative value of the three
tax benefits can be seen by looking at each expense level in the table’s first column and then
across the corresponding row. It is not until qualified tuition and fees are $8,500 that the Lifetime
Learning credit produces more tax savings than the Hope credit for a family with one eligible
student ($1,700 and $1,650, respectively). Because EGTRRA capped the maximum amount that
may be taken as an adjustment against income at $4,000, the reduction in income tax liability
yielded by the higher education deduction cannot match the tax savings of the Hope credit.
The comparative value of the deduction and the Lifetime Learning credit for families is more
complex, being affected both by the deduction’s limit on qualified expenses and a taxpayer’s
marginal tax rate. The $4,000 tuition and fee cap means that the higher education deduction
produces a maximum reduction in income tax liability of $600 for a family with a 15% marginal
tax rate and of $1,000 for family with a 25% marginal tax rate, both of whom have an AGI below
the credit’s income phase-out range. At $4,000 in qualified expenses, the Lifetime Learning credit
is worth $800 (0.20 x $4,000), which is a smaller tax savings than the deduction affords for the
family with the higher (25%), but not lower (15%), marginal tax rate. Generally, for families who
have an AGI that allows them to take the full Lifetime Learning credit or the deduction, who
incur tuition and fees of $4,000 or less, and who have a marginal tax rate above 20%, the
deduction will be worth more than the credit.
Table 3. Examples of Tax Savings from the Higher Education Tax Credits and
Value of Tax Benefit per Return
Higher Education Deduction
Tuition and Hope Scholarship Lifetime Learning 15% Marginal Tax a25% Marginal Tax b
Fees Credit Credit Rate Rate
350 350 70 53 88
1,000 1,000 200 150 250
2,300c 1,650 440 345 575
4,000 1,650 800 600 1,000
6,200d 1,650 1,240 600 1,000
8,500 1,650 1,700 600 1,000
10,000 1,650 2,000 600 1,000
24,000e 1,650 2,000 600 1,000
Source: Congressional Research Service.
a. Represents married-couple family filing jointly with one child enrolled full-time in the freshman year of
college at an eligible institution of higher education with an AGI below the Hope and Lifetime Learning
credits’ income phase-out range.
b. Represents married-couple family filing jointly with one child enrolled full-time in the freshman year of
college at an eligible institution of higher education with an AGI below the Hope and Lifetime Learning
credits’ income phase-out range.
c. Average tuition and fees at two-year public postsecondary institution is $2,361 in 2007-2008, according to
The College Board, Trends in College Pricing 2007.
d. Average tuition and fees at four-year public postsecondary institution (in-state) is $6,185 in 2007-2008,
according to The College Board, Trends in College Pricing 2007.
e. Average tuition and fees at four-year private postsecondary institution is $23,712 in 2007-2008, according
to The College Board, Trends in College Pricing 2007.
An individual’s tax liability level essentially functions as a floor for the credits. In other words,
the Hope and Lifetime Learning credits can only provide assistance to those whose income is not
completely offset by standard deductions and personal or dependent exemptions. If an
individual’s tax liability is below the maximum value of the credit, only the lesser amount may be
claimed. According to one analysis based upon tax returns for 1999, “half of the higher education 14
tax credit beneficiaries were not able to take the full credit for which they were eligible.”
Insufficient tax liability to claim an education credit’s maximum value can come about not only
through low income levels but also through “competing credits.” In other words, other tax credits
for which an individual is eligible, such as the dependent care tax credit, may reduce the filer’s
income tax liability below the amount of the education credits. For instance, if a tax filer has
$1,000 in tax liability and qualifies for a $480 dependent care tax credit, $1,500 Hope credit for
one student, and a $1,000 Lifetime Learning credit for another student, the filer can only receive a
total tax benefit of $1,000 (i.e., the tax liability is less than the aggregate of credits for which the
taxpayer is eligible).
Taxpayers seeking to claim the education credits also may be affected by the alternative minimum
tax provisions that limit the aggregate nonrefundable personal credits a taxpayer can claim. As a
result, some of these taxpayers may find the deduction to be a preferable option.
In contrast to the credits which reduce an individual’s tax liability on a dollar for dollar basis, the
deduction reduces a taxpayer’s AGI. As previously shown, the potential impact of that reduction
on tax liability is realized through the taxpayer’s marginal tax rate. Further, some taxpayers may
have such limited tax liability before the application of the deduction that its actual benefit will be
Students attending postsecondary education institutions where the qualified higher education
expenses are less than the maximum allowable tax benefits will not be able to claim their full
benefits. At many public institutions, low tuition and fee levels are likely to limit the ability to
realize the full tax benefits. For the Hope credit, qualified higher education expenses must be at
least $2,200 for the maximum credit to be realized. As noted in Table 3, two-year public
institutions have tuition and fees in 2007-2008 that average about that level ($2,361). Realizing
the full value of the Lifetime Learning credit may be difficult for many students at public
institutions in general: qualified expenses have to be at least $10,000 to actualize the maximum
Lifetime Learning credit of $2,000, while the average tuition and fees at four-year public
institutions in 2007-2008 is a much lower $6,185.
For the deduction, a taxpayer can claim the maximum tax-rate-dependent value only if qualified
expenses are $4,000. At $4,000, only the average tuition and fees at two-year public institutions
are less. The average tuition and fees of $6,185 at four-year public institutions in 2007-2008 is
somewhat greater than the cap on qualified expenses. In contrast, the average tuition and fees of
$23,712 at four-year private institutions in 2007-2008 far exceeds any of the tax benefit
maximums. Tuition and fees are probably sufficiently high at many of these institutions to pose
no barrier on their own to realization of the full value of the credits and deduction.
The ability to capture the full value of these tax benefits is further limited by their being claimed
to reimburse students and their families only for the net cost of qualified expenses, that is, the
14 Bridget Terry Long, The Impact of Federal Tax Credits for Higher Education Expenses, NBER Working Paper 9553
(Cambridge, MA: National Bureau of Economic Research, February 2003). (Hereafter cited as Long, The Impact of
Federal Tax Credits.)
qualified expenses remaining after any non-taxable educational assistance received (exclusive of
loans and gifts) is subtracted. This reduces, if not eliminates, the tax benefits for many students
receiving relatively large amounts of grant or scholarship aid. This is particularly the case for
students receiving relatively large federal Pell Grant awards. Pell Grants are need-based grants
that, in the 2007-2008 award year, provide a maximum of $4,310 to the neediest students (i.e.,
students whose families are expected to contribute no resources toward postsecondary education
costs). Students attending institutions with low tuition and fee charges and receiving large Pell
Grants may have little or no net qualified expenses remaining for which to claim an education
credit or deduction. At the same time, these low-income students and their families may not have
much if any tax liability, also restricting their ability to benefit from the credits or deduction.
As a result, students attending higher cost institutions, and those receiving relatively little grant or
scholarship aid, are well positioned to capture a good deal of the potential value of their Hope and
Lifetime Learning credits and higher education deduction, assuming their families have sufficient
tax liability to realize the maximum benefit from the credits or deduction.
The introduction of the higher education tax benefits represented a departure from the federal
government’s more common practice of primarily making aid available through the traditional
student aid delivery system. Given that the federal government is the primary provider of direct
aid to students, and tax benefits have quickly grown to become a major component of the federal
aid effort, considerable discussion has emerged related to the merits of providing aid through the
Providing students financial support toward meeting the costs of college through the federal
income tax system has a number of advantages and disadvantages relative to the traditional
process of providing grants, loans, and work support. For example, one issue that distinguishes
the traditional student aid system and the tax system is the timing of the awards. The traditional
system provides aid such as grants and loans prior to the arrival of tuition bills. Tax benefits, in
contrast, require families to make an initial capital outlay, which is “reimbursed” later in the
academic year through tax refunds or reduced tax payments. This difference may limit the
attractiveness of the tax system, at least for lower-income students who may not be able to meet
current expenses that will be partially or fully reimbursed by a later tax benefit. Nevertheless, it is
possible for taxpayers to adjust their tax withholding throughout the year to realize the tax
benefits earlier; this would require some sophistication on the part of taxpayers. Further, for
students enrolling in consecutive years, the tax benefit for a previous year may be provided in
time to help meet the upcoming year’s educational expenses. Finally, to the extent that these tax
benefits are available primarily to middle- and upper middle-income individuals, the timing issue
may be less important.
Tax credits and deductions offer the advantage of streamlining the delivery of funds to aid
recipients who directly claim their financial assistance as part of their annual tax-filing process,
whereas traditional student aid administered by Title IV is delivered through a relatively
cumbersome and labor-intensive process that requires considerable effort on the part of the
applicant, financial aid officers, ED personnel, and loan servicers, in some cases. These
individuals must submit and gather financial data, certify student eligibility for aid, monitor
enrollment status, disburse funds, and deal with refunds and account reconciliation. Still, some 15
have criticized the complexity of the process for taxpayers seeking to claim the tax benefits.
Further, there are institutional reporting requirements associated with these tax provisions that
require institutions to report either the aggregate amount of payments received, or the aggregate
amount billed, for qualified expenses during the calendar year with respect to individuals enrolled 16
for any academic period.
Given the extensive system already in place, the addition of the tax benefits, albeit delivered
through an arguably more streamlined process, may actually increase the complexity of the
overall national effort to help students and their families meet college costs. With the availability
of the tax credits and the deduction, students and their families seeking to realize as much
federally financed support as possible for college expenses must navigate not only the traditional
financial aid system but also the federal income tax system. Potentially, the tax benefits may more
likely be claimed successfully by sophisticated filers.
By statute, the receipt of the tax credits does not affect a student’s eligibility for federal student
aid or the amount of federal student aid that the student receives. Specifically, HEA Section
480(a)(2) specifies that in calculating what a student and his or her family are expected to
contribute toward college costs (the expected family contribution or EFC), the tax credits cannot
be considered income or assets for purposes of that calculation. Further Section 480(j)(2)
provides that in determining a student’s need for HEA Title IV aid—cost of attendance minus the
EFC and all other non-Title IV assistance—the credits are not to be included as non-Title IV
assistance. This is important because inclusion of the credits as non-Title IV assistance would in
effect reduce a student’s need, thereby also affecting his or her eligibility for and the amount of
Title IV need-based aid. It should be noted that there is no comparable language in the HEA
governing the interaction between the higher education deduction and the Title IV assistance. As
a result, it is possible that some taxpayers who can take the deduction will, in turn, be found to
have less financial need for traditional student aid.
Tax benefits and Title IV aid may interact in the federal funding process. It is possible that, in
congressional deliberations over the budget and spending for federal programs, the forgone tax
revenue associated with the tax benefit provisions may have a negative impact on the willingness
or ability of Congress to devote funds to the traditional federal student aid programs.
15 See, for example Thomas R. Wolanin, Rhetoric and Reality: Effects and Consequences of the HOPE Scholarship,
The Institute for Higher Education Policy, April 2001. (Hereafter cited as Wolanin, Rhetoric and Reality.)
16 Department of the Treasury, Internal Revenue Service, “Information Reporting for Qualified Tuition and Related
Expenses; Magnetic Media Filing Requirements for Information Returns” 67 Federal Register 244, pp. 77687-77678,
December 19, 2002.
The limited evidence available suggests that financial aid officers are far from uniform in whether
or how they consider the tax benefits when packaging financial aid for students. Indeed, it is not
clear whether the majority actively factors the tax benefits into this process at all.
Financial aid officers who want to factor the value of the tax credits into the aid package may find
the effort complicated by the absence of information about the actual value of the benefits
students will receive. As noted earlier, because the actual value of the tax benefits are not known
until they are claimed, generally no later than April 15 of the year after the payment for qualified
expenses are made, it would be next to impossible to determine their value during the aid
packaging process that generally occurs during the late summer months.
Certain other aspects of the design of the tax benefits may make it difficult to infer their value
before they are claimed. The actual value of the tax benefits to recipients is affected by a series of
offsets and limitations that are built into the design of the tax system (for example, as explored
earlier, a recipient must have sufficient tax liability to claim the credit and even then the value of
the credit may be reduced by competing credits that can be claimed). The potential effects of
these internal offsets and limitations make it hard for financial aid officers to project the value of
the credit when packaging aid. Thus, if there are discrepancies between the credits’ actual value
and the value assumed by financial aid officers who would take the tax provisions into account in
packaging aid, recipients may be awarded more or less aid than necessary.
The effect of the tax benefits on the setting of tuition levels by states is largely unknown. State
higher education officials face challenges similar to those of financial aid officers stemming from
the hidden value of tax credits. They must make decisions about tuition levels and about the
structure and targeting of state aid programs which can be shaped in part by assumptions about
the value of aid they expect will be available to students.
Precisely gauging the net financial benefit flowing from the tax provisions is problematic.
However, some states have considered raising the tuition and fees in some schools to enable their 17
students to “capture” as much of the tax benefits as possible. Some states have also considered
targeting their state grant programs in ways that avoid inhibiting students’ ability to capture the
full value of other credits. Such decisions regarding tuition and aid will affect whether and how
the tax benefits will enhance recipients’ ability to finance postsecondary education.
17 One study that explored available information on this issue concludes that the Hope Scholarship provides resources
that “are an incentive for private and public institutions of higher education to increase tuition or to reduce aid to
students. Indeed, the HOPE Scholarship benefits institutions of higher education only if they raise tuition or decrease
student aid. Several states have considered or undertaken strategies to capture the HOPE Scholarship through either
tuition increases or aid reduction.” (Wolanin, Rhetoric and Reality, p. 29.) Another report suggests that the credits’
inception was associated with disproportionately large tuition increases at schools whose prior tuition levels were less
than needed to maximize the Hope credit. (Long, The Impact of Federal Tax Credits.)
Linda Levine Charmaine Mercer
Specialist in Labor Economics