Education Tax Credits

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106388-98]

RIN 1545-AW65

Education Tax Credits

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and requests to hold a

videoconference public hearing.

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SUMMARY: This document contains proposed regulations relating to the

Hope Scholarship Credit and the Lifetime Learning Credit in section 25A

of the Internal Revenue Code. These proposed regulations provide

guidance to individuals who may claim the Hope Scholarship Credit or

the Lifetime Learning Credit for certain postsecondary educational

expenses. This document also announces that a public hearing will be

held on the proposed regulations upon request and that persons outside

the Washington, DC, area who wish to testify at the hearing may request

that the IRS videoconference the hearing to their sites.

DATES: Written or electronically generated comments must be received by

April 6, 1999. Requests to videoconference the hearing to other sites

must be received by March 8, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106388-98), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-

106388-98), Courier's Desk, Internal Revenue Service, 1111 Constitution

Avenue., NW., Washington, DC. Alternatively, taxpayers may submit

comments electronically via the internet by selecting the ``Tax Regs''

option on the IRS Home Page, or by submitting comments directly to the

IRS internet site at http://www.irs.ustreas.gov/prod/tax__regs/

comments.html. The IRS will publish the time and date of the public

hearing and the locations of any videoconferencing sites in the Federal

Register.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Donna

Welch, (202) 622-4910; concerning submissions of comments, the hearing,

and/or to be placed on the building access list to attend the hearing,

contact Michael L. Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed

rulemaking has been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the collection of information should be

sent to the Office of Management and Budget, Attn: Desk Officer for the

Department of the Treasury, Office of Information and Regulatory

Affairs, Washington, DC 20503, with copies to the Internal Revenue

Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC

20224. Comments on the collection of information should be received by

March 8, 1999. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the

proper performance of the functions of the Internal Revenue Service,

including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed

collection of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the proposed collection of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in

Sec. 1.25A-1(d) and (f). Taxpayers must elect to claim an education

credit by attaching Form 8863, ``Education Credits (Hope and Lifetime

Learning Credits),'' to a timely filed (including extensions) federal

income tax return for the taxable year in which a credit is claimed.

This collection of information is required in order for a taxpayer to

elect to claim an education credit. This information will be used to

carry out the internal revenue laws. The likely respondents are

individuals.

The reporting burden contained in Sec. 1.25A-1(d) and (f) is

reflected in the burden of Form 8863, ``Education Credits (Hope and

Lifetime Learning Credits),'' and Form 1040, ``U.S. Individual Income

Tax Return.''

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

The Taxpayer Relief Act of 1997 (Public Law 105-34 (111 Stat. 788)

(TRA '97)) added section 25A to the Internal Revenue Code to provide

the Hope Scholarship Credit and the Lifetime Learning Credit (education

credits). In general, the Hope Scholarship Credit and the Lifetime

Learning Credit allow taxpayers to claim a nonrefundable credit against

their federal income taxes for certain postsecondary educational

expenses. On November 17, 1997, the IRS published Notice 97-60 (1997-46

I.R.B. 8) to provide general guidance on the higher education tax

incentives enacted by TRA '97, including the Hope Scholarship Credit

and the Lifetime Learning Credit. This document contains proposed

amendments to the Income Tax Regulations (26 CFR part 1) to provide

detailed guidance on the education credits in section 25A.

TRA '97 also added section 6050S to the Code, which requires

eligible educational institutions to file

[[Page 795]]

information returns to assist taxpayer and the IRS in determining the

education credit that taxpayers may claim under section 25A. The IRS

has published several notices outlining the limited information returns

that are required for 1998 and 1999. On December 22, 1997, the IRS

published Notice 97-73 (1997-51 I.R.B. 16), which describes the

information that must be reported for 1998. On September 8, 1998, the

IRS published Notice 98-46 (1998-36 I.R.B. 21), which extends the

application of Notice 97-73 to information returns required under

section 6050S for 1999. Finally, on December 7, 1998, the IRS published

Notice 98-59 (1998-49 I.R.B. 16), which modified the two prior Notices

by providing that an eligible educational institution is not required

to file information returns under section 6050S for 1998 or 1999 with

respect to either: (1) students who are enrolled during the year only

in courses for which the student receives no academic credit from the

educational institution; or (2) nonresident alien students, unless

requested to do so by the student. The IRS and the Treasury Department

intend to issue separate regulations on the information reporting

required under section 6050S for years after 1999.

Explanation of Provisions

1. Calculation of Education Credit and General Eligibility Requirements

Under the proposed regulations, a taxpayer may claim a

nonrefundable education credit equal to the total of the Hope

Scholarship Credit and the Lifetime Learning Credit allowed for the

taxpayer, the taxpayer's spouse, and any claimed dependents. An

education credit in excess of a taxpayer's tax liability for the

taxable year can not be refunded. As with other personal credits,

section 25A does not allow a carryforward of an unused education credit

or a carryforward of excess qualified expenses.

The proposed regulations provide rules for the coordination of the

Hope Scholarship Credit and the Lifetime Learning Credit. The proposed

regulations provide that, in the same taxable year, a taxpayer may

claim a Hope Scholarship Credit for each eligible student's qualified

tuition and related expenses and a Lifetime Learning Credit for one or

more other students' qualified tuition and related expenses. The

regulations provide that a taxpayer may claim either the Hope

Scholarship Credit or the Lifetime Learning Credit, but not both, for

the qualified tuition and related expenses of the same student in the

same taxable year. A Hope Scholarship Credit may be claimed for the

qualified tuition and related expenses (up to a specified limit

described below) of each eligible student. The Lifetime Learning Credit

may be claimed for the aggregate amount of qualified tuition and

related expenses (up to a specified limit described below) of those

students for whom no Hope Scholarship Credit is claimed.

Consistent with the income limitations in section 25A(d), the

proposed regulations provide that the education credit allowed is

phased out for taxpayers with modified adjusted gross income between

$40,000 and $50,000 ($80,000 and $100,000 for taxpayers filing a joint

return) for the taxable year. For taxable years beginning after 2001,

these amounts will be adjusted for inflation. Based on the definition

in section 25A(d)(3), the regulations define modified adjusted gross

income as the adjusted gross income (as defined in section 62) of the

taxpayer for the taxable year increased by any amount excluded from

gross income under section 911, 931, or 933 (relating to income earned

abroad or from certain U.S. possessions or Puerto Rico). The amount of

an otherwise allowable education credit for a taxable year that is

reduced solely by reason of the modified adjusted gross income

limitation can not be carried forward and claimed in a subsequent

taxable year.

Consistent with the requirements in section 25A(e)(1), the proposed

regulations provide that a taxpayer must elect to claim the education

credit. The election must be made by attaching Form 8863, ``Education

Credits (Hope and Lifetime Learning Credits),'' to the taxpayer's

federal income tax return for the taxable year in which the credit is

claimed. Consistent with the identification requirements in section

25A(g)(1), the regulations provide that a taxpayer must include on the

federal income tax return the name and taxpayer identification number

of each student for whom the credit is claimed.

Consistent with the requirements in section 25A(e)(2), the proposed

regulations provide that no education credit is allowed for a taxable

year for the qualified tuition and related expenses of a student if:

(1) During the taxable year, a distribution is made to, or on behalf

of, the student from an education individual retirement account

described in section 530(b); and (2) any portion of the distribution is

excluded from gross income under section 530(d)(2).

The proposed regulations provide guidance on the rules for claiming

an education credit in the case of a dependent. The regulations provide

that, if the student is a claimed dependent of another taxpayer, only

that taxpayer may claim the education credit for the student's

qualified tuition and related expenses. The regulations explain that,

if the taxpayer is eligible to, but does not, claim the student as a

dependent, only the student may claim the education credit for the

student's qualified tuition and related expenses.

2. Definitions

The proposed regulations provide that a claimed dependent is a

dependent (as defined in section 152) for whom a deduction under

section 151 is allowed on the taxpayer's federal income tax return for

the taxable year in which the credit is claimed.

Based on the requirements of section 25A(f)(2), the proposed

regulations provide that an eligible educational institution means a

college, university, vocational school, or other postsecondary

educational institution that: (1) Is described in section 481 of the

Higher Education Act of 1965 (HEA) (20 U.S.C. 1088) as in effect on

August 5, 1997 (generally all accredited public, nonprofit, and

proprietary postsecondary institutions); and (2) participates in a

federal student financial aid program under title IV of the HEA (20

U.S.C. 1070 et seq.) or is certified by the Department of Education as

eligible to participate in such a program but chooses not to

participate.

The proposed regulations provide that academic period means a

quarter, semester, trimester, or other period of study (such as a

summer school session) as reasonably determined by the eligible

educational institution. Neither section 25A nor its legislative

history defines the term academic period. Additionally, the Department

of Education does not have a recognized definition of academic period.

The definition in the regulation is intended to include institutions

that use traditional academic terms and institutions that do not use

academic terms, but for example use clock hours or credit hours. The

IRS and Treasury invite comments on this definition of academic period

as well as suggestions on alternative definitions.

Based on the definition in section 25A(f)(1), the proposed

regulations define qualified tuition and related expenses as the

tuition and fees required for the enrollment or attendance of a student

for courses of instruction at an eligible educational institution. This

definition is generally consistent with the definition of tuition and

fees contained in section 472(1) of

[[Page 796]]

the HEA (20 U.S.C. 1087ll(1)). See H.R. Conf. Rep. No. 599, 105th

Cong., 2d Sess., at p. 321 (1998). The regulations provide that, in

general, the test for determining whether a fee is treated as a

qualified tuition and related expense is whether the fee is required to

be paid to the eligible educational institution by students as a

condition of the students' enrollment or attendance at the institution.

The regulations specifically provide that qualified tuition and related

expenses include fees for books, supplies, and equipment used in a

course of study only if the fees must be paid to the eligible

educational institution for the enrollment or attendance of the student

at the institution. Similarly, the regulations provide that, in

general, qualified tuition and related expenses include nonacademic

fees (fees charged by an eligible educational institution that are not

used directly for, or allocated to, an academic course of study) only

if the fees must be paid to the eligible educational institution for

the enrollment or attendance of the student at the institution.

However, based on the legislative history to section 25A, the

proposed regulations provide that qualified tuition and related

expenses do not include the costs of room and board, insurance, medical

expenses (such as student health fees), transportation, and similar

personal, living, or family expenses, regardless of whether the fees

must be paid to the eligible educational institution for the enrollment

or attendance of the student at the institution. See H.R. Conf. Rep.

No. 220, 105th Cong., 1st Sess., at pp. 343, 346 (1997). Further, based

on the limitations in section 25A (f)(1)(B) and (c)(2)(B), the

regulations provide that qualified tuition and related expenses do not

include expenses that relate to any course of instruction or other

education that involves sports, games, hobbies, or any noncredit

course, unless the course 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.

3. Hope Scholarship Credit

The Hope Scholarship Credit is a per student credit that may be

claimed for each eligible student. Consistent with the provisions of

section 25A(b)(1), the proposed regulations provide that for taxable

years beginning before 2002 the maximum Hope Scholarship Credit amount

is $1,500 (100 percent of the first $1,000 of the qualified tuition and

related expenses paid during the taxable year for education furnished

to an eligible student during any academic period beginning in the

taxable year or treated as beginning in the taxable year, plus 50

percent of the next $1,000 of such expenses paid with respect to that

student). For taxable years beginning after 2001, the $1,000 amounts

will be adjusted for inflation. Consistent with the provisions of

section 25A(b)(2)(A), the regulations provide that the Hope Scholarship

Credit is allowed for only two taxable years for each eligible student.

Based on the requirements in section 25A(b) (2) and (3), the

proposed regulations define an eligible student for purposes of the

Hope Scholarship Credit as a student who meets all of the following

requirements: (1) For at least one academic period during the taxable

year, the student enrolls at an eligible educational institution in a

program leading toward a postsecondary degree, certificate, or other

recognized postsecondary educational credential (degree requirement);

(2) for at least one academic period during the taxable year, the

student enrolls for at least half of the normal full-time work load for

the course of study the student is pursuing (work load requirement);

(3) as of the beginning of the taxable year, the student has not

completed the first two years of postsecondary education at an eligible

educational institution (year of study requirement); and (4) the

student has not been convicted of a federal or state felony offense for

the possession or distribution of a controlled substance as of the end

of the taxable for which the credit is claimed (felony drug conviction

restriction).

The proposed regulations explain that the student meets the work

load requirement if the student is enrolled for at least half of the

normal full-time work load, as determined by the eligible educational

institution. The regulations provide that the educational institution's

standards for a half-time work load must equal or exceed the standards

established by the Department of Education under the HEA and set forth

in 34 CFR 674.2(b) for a half-time undergraduate student.

The proposed regulations explain that whether a student has

completed the first two years of postsecondary education as of the

beginning of the taxable year is based on whether the eligible

educational institution the student is enrolled in awards the student

two years of academic credit for postsecondary course work completed by

the student prior to the beginning of the taxable year. However, the

regulations provide that any academic credit awarded by the educational

institution solely on the basis of the student's performance on

proficiency examinations is not taken into account.

The proposed regulations provide that the Hope Scholarship Credit

is effective for expenses paid after December 31, 1997, for education

furnished in academic periods beginning after that date.

4. Lifetime Learning Credit

The Lifetime Learning Credit is a per taxpayer credit, rather than

a per student credit. For taxable years beginning before 2003, the

maximum Lifetime Learning Credit amount is $1,000 (20 percent of up to

$5,000 of the aggregate qualified tuition and related expenses paid

during the taxable year for education furnished to the taxpayer, the

taxpayer's spouse, and any claimed dependent during any academic period

beginning in the taxable year or treated as beginning in the taxable

year). For taxable years beginning on or after 2003, the maximum credit

amount is $2,000 (20 percent of up to $10,000 of the aggregate

qualified tuition and related expenses paid during the taxable year for

education furnished to the taxpayer, the taxpayer's spouse, and any

claimed dependent during any academic period beginning in the taxable

year or treated as beginning in the taxable year).

In contrast to the Hope Scholarship Credit, the Lifetime Learning

Credit is allowed for an unlimited number of years for each student and

does not have a degree requirement, year of study requirement, work

load requirement, or a felony drug conviction restriction. See H.R.

Conf. Rep. No. 220, 105th Cong., 1st Sess., at p. 346-347 (1997).

Therefore, a taxpayer may claim a Lifetime Learning Credit for a

student's qualified tuition and related expenses even if the taxpayer

could not claim a Hope Scholarship Credit for those expenses.

Based on the provisions of section 25A(c)(2)(B) and the legislative

history to section 25A, the proposed regulations provide that, for

purposes of claiming a Lifetime Learning Credit, amounts that a

taxpayer is required to pay for a course at an eligible educational

institution are qualified tuition and related expenses if the course is

either part of a postsecondary degree program or is part of a nondegree

program that is taken by the student to acquire or improve job skills.

The legislative history explains that the Lifetime Learning Credit is

available with respect to any course of instruction at any eligible

educational institution (whether the student is enrolled on a full-

time, half-time, or less than half-time basis) to acquire or improve

job skills of the student. See

[[Page 797]]

H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess., at p. 346-347 (1997).

The proposed regulations provide that the Lifetime Learning Credit

is effective for expenses paid after June 30, 1998, for education

furnished in academic periods beginning after that date.

5. Special Rules Relating to Characterization and Timing of Payments

The proposed regulations provide guidance on qualified tuition and

related expenses paid by a third party. The regulations provide that,

solely for purposes of section 25A, if a third party makes a payment

directly to an eligible educational institution to pay for a student's

qualified tuition and related expenses, the student is treated as

receiving the payment from the third party, and, in turn, paying the

qualified tuition and related expenses to the institution.

Consistent with the provisions of section 25A(g)(3), the proposed

regulations provide that qualified tuition and related expenses paid by

a student are treated as paid by the taxpayer if the student is a

claimed dependent of the taxpayer.

The proposed regulations provide rules for adjustments to qualified

tuition and related expenses for certain excludable educational

assistance. Consistent with the provisions of section 25A(g)(2) and the

legislative history, the regulations provide that the amount of

otherwise allowable qualified tuition and related expenses paid during

a taxable year must be reduced by the following amounts paid to, or on

behalf of, a student during the taxable year: (1) a qualified

scholarship that is excludable from gross income under section 117; (2)

a veterans' or member of the armed forces' educational assistance

allowance under chapter 30, 31, 32, 34, or 35 of title 38, U.S.C., or

chapter 1606 of title 10, U.S.C.; (3) employer-provided educational

assistance that is excludable from gross income under section 127; and

(4) any other educational assistance that is excludable from gross

income (other than as a gift, bequest, devise, or inheritance within

the meaning of section 102(a)). See H.R. Conf. Rep. No. 220, 105th

Cong., 1st Sess., at p. 343, 347 (1997).

The proposed regulations provide rules for allocating scholarships

and fellowship grants among expenses. The regulations provide that a

scholarship or fellowship grant is treated as a qualified scholarship

excludable from income under section 117 (and thereby reduces the

amount of qualified tuition and related expenses that a taxpayer may

otherwise include in claiming an education credit) unless either: (1)

the student reports the grant as income on the student's federal income

tax return; or (2) the grant must be applied, by its terms, to expenses

other than qualified tuition and related expenses within the meaning of

section 117(b)(2), such as room and board.

The proposed regulations provide guidance on the timing rules for

claiming an education credit. Consistent with the general rule in

section 25A(b)(1) and (c)(1), the regulations provide that an education

credit generally is allowed only for payments of qualified tuition and

related expenses that cover an academic period beginning in the same

taxable year as the year the payment is made. However, consistent with

the specific prepayment rule in section 25A(g)(4), the regulations

provide that, if qualified tuition and related expenses are paid during

a taxable year to cover an academic period that begins during the first

three months of the taxpayer's next taxable year, an education credit

is allowed only in the taxable year in which the expenses are paid.

Note, however, that because the Hope Scholarship Credit does not apply

to expenses paid before January 1, 1998, and the Lifetime Learning

Credit does not apply to expenses paid before July 1, 1998, the

prepayment rule does not apply for tuition paid in 1997 to cover an

academic period beginning in 1998.

Consistent with the legislative history to section 25A, the

proposed regulations provide that an education credit may be claimed

for the qualified tuition and related expenses paid with the proceeds

of a loan only in the taxable year in which the expenses are paid, and

not in the taxable year in which the loan is repaid. See H.R. Conf.

Rep. No. 220, 105th Cong., 1st Sess., at p. 342, 346 (1997). In order

to provide taxpayers with a date certain for payment, the regulations

provide that loan proceeds disbursed directly to an educational

institution are treated as paid on the date of the disbursement.

However, if the taxpayer does not know the date of the disbursement,

the taxpayer must treat qualified tuition and related expenses as paid

on the last date prescribed for payment by the educational institution.

Consistent with the directive in section 25A(i), the proposed

regulations provide rules for refunds of qualified tuition and related

expenses. The regulations provide that, if a payment and a refund of

qualified tuition and related expenses occur in the same taxable year,

the amount of qualified tuition and related expenses for the taxable

year is calculated by adding all qualified tuition and related expenses

paid for the taxable year, and subtracting any refund of the expenses

received from the eligible educational institution during the same

taxable year.

The proposed regulations provide that, if, in a taxable year, a

taxpayer (or the taxpayer's spouse or a claimed dependent) receives a

refund from an eligible educational institution of qualified tuition

and related expenses paid in a prior taxable year and the refund is

received before the taxpayer files a federal income tax return for the

prior taxable year, the amount of the qualified tuition and related

expenses for the prior taxable year must be reduced by the amount of

the refund.

Similar to the tax benefit rule, the proposed regulations provide

that, if, in a taxable year, a taxpayer (or the taxpayer's spouse or a

claimed dependent) receives a refund of qualified tuition and related

expenses for which the taxpayer claimed an education credit in a prior

taxable year, the tax for the subsequent taxable year is increased by

the recapture amount. The recapture amount is the difference between

the credit claimed in the prior taxable year and the redetermined

credit. The redetermined credit is computed by reducing the amount of

the qualified tuition and related expenses for which a credit was

claimed in the prior taxable year by the amount of the refund of the

qualified tuition and related expenses (redetermined qualified

expenses), and computing the credit using the redetermined qualified

expenses and the relevant facts and circumstance of the prior taxable

year, such as modified adjusted gross income.

The proposed regulations provide that, if, in a taxable year, any

excludable educational assistance is received for the qualified tuition

and related expenses paid during a prior taxable year, the educational

assistance is treated as a refund of qualified tuition and related

expenses. In this situation, if a taxpayer (or the taxpayer's spouse or

a claimed dependent) receives any excludable educational assistance

before the taxpayer files a federal income tax return for the prior

taxable year, the amount of the qualified tuition and related expenses

for the prior taxable year is reduced by the amount of the excludable

educational assistance. However, if a taxpayer (or the taxpayer's

spouse or claimed dependent) receives excludable educational assistance

after the taxpayer has filed a federal income tax return for the prior

taxable year, any education credit claimed for the prior taxable year

is subject to recapture.

[[Page 798]]

6. Proposed Effective Date

These regulations are proposed to be effective on the date they are

published in the Federal Register as final regulations. Taxpayers may

rely on these proposed regulations for guidance pending the issuance of

final regulations. If, and to the extent, future guidance is more

restrictive than the guidance in the proposed regulations, the future

guidance will be applied without retroactive effect.

Special Analyses

It has been determined that these proposed regulations are not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations, and because the regulations do not

impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to

section 7805(f), this notice of proposed rulemaking will be submitted

to the Chief Counsel for Advocacy of the Small Business Administration

for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written and electronic comments that

are submitted timely to the IRS. The IRS and Treasury specifically

request comments on the clarity of the proposed regulations and how

they can be made easier to understand. All comments will be available

for public inspection and copying.

A public hearing will be scheduled in the Internal Revenue

Building, 1111 Constitution Avenue, NW., Washington, DC. The IRS

recognizes that persons outside the Washington, DC, area may also wish

to testify at the public hearing through videoconferencing. Requests to

include videoconferencing sites must be received by March 8, 1999. If

the IRS receives sufficient indications of interest to warrant

videoconferencing to a particular city, and if the IRS has

videoconferencing facilities available in that city on the date the

public hearing is to be scheduled, the IRS will try to accommodate the

requests.

The IRS will publish the time and date of the public hearing and

the locations of any videoconferencing sites in an announcement in the

Federal Register.

Drafting information. The principal author of the regulations is

Donna Welch, Office of Assistant Chief Counsel (Income Tax and

Accounting). However, other personnel from the IRS and the Treasury

Department participated in the development of the regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.25A-0 also issued under section 26 U.S.C. 25A(i).

Section 1.25A-1 also issued under section 26 U.S.C. 25A(i).

Section 1.25A-2 also issued under section 26 U.S.C. 25A(i).

Section 1.25A-3 also issued under section 26 U.S.C. 25A(i).

Section 1.25A-4 also issued under section 26 U.S.C. 25A(i).

Section 1.25A-5 also issued under section 26 U.S.C. 25A(i). * * *

Par. 2. Sections 1.25A-0 through 1.25A-5 are added to read as

follows:

Sec. 1.25A-0 Table of contents.

This section lists captions contained in Secs. 1.25A-1, 1.25A-2,

1.25A-3, 1.25A-4, and 1.25A-5.

Sec. 1.25A-1 Calculation of education credit and general

eligibility requirements.

(a) Amount of education credit.

(b) Coordination of Hope Scholarship Credit and Lifetime

Learning

Credit.

(1) In general.

(2) Hope Scholarship Credit.

(3) Lifetime Learning Credit.

(4) Examples.

(c) Limitation based on modified adjusted gross income.

(1) In general.

(2) Modified adjusted gross income defined.

(3) Inflation adjustment.

(d) Election.

(e) Coordination with Education IRA.

(f) Identification requirement.

(g) Claiming the credit in the case of a dependent.

(1) In general.

(2) Examples.

(h) Married taxpayers.

(i) Nonresident alien taxpayers and dependents.

Sec. 1.25A-2 Definitions.

(a) Claimed dependent.

(b) Eligible educational institution.

(1) In general.

(2) Rules on federal financial aid programs.

(c) Academic period.

(d) Qualified tuition and related expenses.

(1) In general.

(2) Required fees.

(i) In general.

(ii) Books, supplies, and equipment.

(iii) Nonacademic fees.

(3) Personal expenses.

(4) Treatment of comprehensive fees.

(5) Hobby courses.

(6) Examples.

Sec. 1.25A-3 Hope Scholarship Credit.

(a) Amount of the credit.

(1) In general.

(2) Maximum credit.

(b) Per student credit.

(1) In general.

(2) Example.

(c) Credit allowed for only two taxable years.

(d) Eligible student.

(1) Eligible student defined.

(i) Degree requirement.

(ii) Work load requirement.

(iii) Year of study requirement.

(iv) No felony drug conviction.

(2) Examples.

(e) Academic period for prepayments.

(1) In general.

(2) Example.

(f) Effective date.

Sec. 1.25A-4 Lifetime Learning Credit.

(a) Amount of the credit.

(1) Taxable years beginning before January 1, 2003.

(2) Taxable years beginning after December 31, 2002.

(3) Coordination with the Hope Scholarship Credit.

(4) Examples.

(b) Credit allowed for unlimited number of taxable years.

(c) Both degree and nondegree courses are eligible for the

credit.

(1) In general.

(2) Examples.

(d) Effective date.

Sec. 1.25A-5 Special rules relating to characterization and

timing of payments.

(a) Payments of educational expenses by a third party.

(1) In general.

(2) Example.

(b) Expenses paid by dependent.

(1) In general.

(2) Example.

(c) Adjustment to qualified tuition and related expenses for

certain excludable educational assistance.

(1) In general.

(2) No adjustment for excludable educational assistance

attributable to expenses paid in a prior year.

(3) Allocation of scholarships and fellowship grants.

(4) Examples.

(d) No double benefit.

(e) Timing rules.

(1) In general.

(2) Prepayment rule.

(i) In general.

(ii) Example.

(3) Expenses paid with loan proceeds.

(f) Refund of qualified tuition and related expenses.

(1) Payment and refund of qualified tuition and related expenses

in the same taxable year.

[[Page 799]]

(2) Payment of qualified tuition and related expenses in one

taxable year and refund in subsequent taxable year before return

filed for prior taxable year.

(3) Payment of qualified tuition and related expenses in one

taxable year and refund in subsequent taxable year.

(i) In general.

(ii) Recapture amount.

(4) Excludable educational assistance received in a subsequent

taxable year treated as refund.

(5) Examples.

Sec. 1.25A-1 Calculation of education credit and general eligibility

requirements.

(a) Amount of education credit. An individual taxpayer is

allowed a nonrefundable education credit against income tax imposed

by chapter 1 of the Internal Revenue Code for the taxable year. The

amount of the education credit is the total of the Hope Scholarship

Credit (as described in Sec. 1.25A-3) plus the Lifetime Learning

Credit (as described in Sec. 1.25A-4). For limitations on the

credits allowed by subpart A of part IV of subchapter A of chapter

1, see section 26.

(b) Coordination of Hope Scholarship Credit and Lifetime Learning

Credit--(1) In general. In the same taxable year, a taxpayer may claim

a Hope Scholarship Credit for each eligible student's qualified tuition

and related expenses (as defined in Sec. 1.25A-2(d)) and a Lifetime

Learning Credit for one or more other students' qualified tuition and

related expenses. However, a taxpayer may not claim both a Hope

Scholarship Credit and a Lifetime Learning Credit with respect to the

same student in the same taxable year.

(2) Hope Scholarship Credit. Subject to certain limitations, a Hope

Scholarship Credit may be claimed for the qualified tuition and related

expenses paid during a taxable year with respect to each eligible

student (as defined in Sec. 1.25A-3(d)). Qualified tuition and related

expenses paid during a taxable year with respect to any student for

whom a Hope Scholarship Credit is claimed may not be taken into account

in computing the amount of the Hope Scholarship Credit with respect to

any other student or the Lifetime Learning Credit.

(3) Lifetime Learning Credit. Subject to certain limitations, a

Lifetime Learning Credit may be claimed for the aggregate amount of

qualified tuition and related expenses paid during a taxable year with

respect to students for whom no Hope Scholarship Credit is claimed.

(4) Examples. The following examples illustrate the rules of this

paragraph (b):

Example 1. In 1999, Taxpayer A pays qualified tuition and

related expenses for his dependent, B, to attend College Y during

1999. Assuming all other relevant requirements are met, Taxpayer A

may claim either a Hope Scholarship Credit or a Lifetime Learning

Credit with respect to dependent B, but not both. See Sec. 1.25A-

3(a) and Sec. 1.25A-4(a).

Example 2. In 1999, Taxpayer C pays $2,000 in qualified tuition

and related expenses for her dependent, D, to attend College Z

during 1999. In 1999, Taxpayer C also pays $500 in qualified tuition

and related expenses to attend a computer course during 1999 to

improve Taxpayer C's job skills. Assuming all other relevant

requirements are met, Taxpayer C may claim a Hope Scholarship Credit

for the $2,000 of qualified tuition and related expenses

attributable to dependent D (see Sec. 1.25A-3(a)) and a Lifetime

Learning Credit for the $500 of qualified tuition and related

expenses incurred to improve her job skills.

Example 3. The facts are the same as in Example 2, except that

Taxpayer C pays $3,000 in qualified tuition and related expenses for

her dependent, D, to attend College Z during 1999. Although a Hope

Scholarship Credit is available only with respect to the first

$2,000 of qualified tuition and related expenses paid with respect

to D (see Sec. 1.25A-3(a)), Taxpayer C may not add the $1,000 of

excess expenses to her $500 of qualified tuition and related

expenses in computing the amount of the Lifetime Learning Credit.

(c) Limitation based on modified adjusted gross income--(1) In

general. The education credit that a taxpayer may otherwise claim is

phased out ratably for taxpayers with modified adjusted gross income

between $40,000 and $50,000 ($80,000 and $100,000 for married

individuals who file a joint return). Thus, taxpayers with modified

adjusted gross income above $50,000 (or $100,000 for joint filers) may

not claim an education credit.

(2) Modified adjusted gross income defined. The term modified

adjusted gross income means the adjusted gross income (as defined in

section 62) of the taxpayer for the taxable year increased by any

amount excluded from gross income under section 911, 931, or 933

(relating to income earned abroad or from certain U.S. possessions or

Puerto Rico).

(3) Inflation adjustment. For taxable years beginning after 2001,

the amounts in paragraph (c)(1) of this section will be increased for

inflation occurring after 2000 in accordance with section 1(f)(3). If

any amount adjusted under this paragraph (c)(3) is not a multiple of

$1,000, the amount will be rounded to the next lowest multiple of

$1,000.

(d) Election. No education credit is allowed unless a taxpayer

elects to claim the credit on the taxpayer's timely filed (including

extensions) federal income tax return for the taxable year in which the

credit is claimed. The election is made by attaching Form 8863,

``Education Credits (Hope and Lifetime Learning Credits),'' (or its

successor) to that federal income tax return.

(e) Coordination with Education IRA. No education credit is allowed

for a taxable year for the qualified tuition and related expenses of a

student if--

(1) During the taxable year, a distribution is made to, or on

behalf of, the student from an education individual retirement account

described in section 530(b) (Education IRA); and

(2) Any portion of the distribution is excluded from gross income

under section 530(d)(2).

(f) Identification requirement. No education credit is allowed

unless a taxpayer includes on the federal income tax return claiming

the credit the name and the taxpayer identification number of the

student for whom the credit is claimed. For rules relating to

assessment for an omission of a correct taxpayer identification number,

see section 6213(b) and (g)(2)(J).

(g) Claiming the credit in the case of a dependent--(1) In general.

If a student is a claimed dependent of another taxpayer, only that

taxpayer may claim the education credit for the student's qualified

tuition and related expenses. However, if the taxpayer is eligible to,

but does not, claim the student as a dependent, only the student may

claim the education credit for the student's qualified tuition and

related expenses.

(2) Examples. The following examples illustrate the rules of this

paragraph (g):

Example 1. In 1999, Taxpayer A pays qualified tuition and

related expenses for his dependent, B, to attend University Y during

1999. Taxpayer A claims B as a dependent on his federal income tax

return. Therefore, assuming all other relevant requirements are met,

Taxpayer A is allowed an education credit on his federal income tax

return, and B is not allowed an education credit on B's federal

income tax return. The result would be the same if B paid the

qualified tuition and related expenses. See Sec. 1.25A-5(b).

Example 2. In 1999, Taxpayer C has one dependent, D. In 1999, D

pays qualified tuition and related expenses to attend University Z

during 1999. Although Taxpayer C is eligible to claim D as a

dependent on her federal income tax return, she does not do so.

Therefore, assuming all other relevant requirements are met, D is

allowed an education credit on D's federal income tax return, and

Taxpayer C is not allowed an education credit on her federal income

tax return, with respect to D's education expenses. The result would

be the same if C paid the qualified tuition and related expenses on

behalf of D. See Sec. 1.25A-5(a).

(h) Married taxpayers. If a taxpayer is married (within the meaning

of section 7703), no education credit is allowed unless the taxpayer

and the taxpayer's

[[Page 800]]

spouse file a joint federal income tax return for the taxable year.

(i) Nonresident alien taxpayers and dependents. If a taxpayer or

the taxpayer's spouse is a nonresident alien for any portion of the

taxable year, no education credit is allowed unless the nonresident

alien is treated as a resident alien by reason of an election under

section 6013(g) or (h). In addition, if a student is a nonresident

alien, a taxpayer may not claim an education credit with respect to the

qualified tuition and related expenses of the student unless the

student is a dependent as defined in section 152. Among other

requirements under section 152, the nonresident alien student must be a

resident of a country contiguous to the United States in order to be

treated as a dependent.

Sec. 1.25A-2 Definitions.

(a) Claimed dependent. A claimed dependent means a dependent (as

defined in section 152) for whom a deduction under section 151 is

allowed on a taxpayer's federal income tax return for the taxable year.

(b) Eligible educational institution--(1) In general. In general,

an eligible educational institution means a college, university,

vocational school, or other postsecondary educational institution that

is--

(i) Described in section 481 of the Higher Education Act of 1965

(20 U.S.C. 1088) as in effect on August 5, 1997, (generally all

accredited public, nonprofit, and proprietary postsecondary

institutions); and

(ii) Participating in a federal financial aid program under title

IV of the Higher Education Act of 1965 (20 U.S.C. 1070 et seq.) or is

certified by the Department of Education as eligible to participate in

such a program but chooses not to participate.

(2) Rules on federal financial aid programs. For rules governing an

educational institution's eligibility to participate in federal

financial aid programs, see 20 U.S.C. 1070 et seq.; 20 U.S.C. 1094; and

34 CFR 600 and 668.

(c) Academic period. Academic period means a quarter, semester,

trimester, or other period of study (such as a summer school session)

as reasonably determined by an eligible educational institution.

(d) Qualified tuition and related expenses--(1) In general.

Qualified tuition and related expenses means tuition and fees required

for the enrollment or attendance of a student for courses of

instruction at an eligible educational institution.

(2) Required fees--(i) In general. Except as provided in paragraph

(d)(3) of this section, the test for determining whether any fee is a

qualified tuition and related expense is whether the fee is required to

be paid to the eligible educational institution as a condition of the

student's enrollment or attendance at the institution.

(ii) Books, supplies, and equipment. Qualified tuition and related

expenses include fees for books, supplies, and equipment used in a

course of study only if the fee must be paid to the eligible

educational institution for the enrollment or attendance of the student

at the institution.

(iii) Nonacademic fees. Except as provided in paragraph (d)(3) of

this section, qualified tuition and related expenses include fees

charged by an eligible educational institution that are not used

directly for, or allocated to, an academic course of instruction only

if the fee must be paid to the eligible educational institution for the

enrollment or attendance of the student at the institution.

(3) Personal expenses. Qualified tuition and related expenses do

not include the costs of room and board, insurance, medical expenses,

transportation, and similar personal, living, or family expenses,

regardless of whether the fee must be paid to the eligible educational

institution for the enrollment or attendance of the student at the

institution.

(4) Treatment of comprehensive fees. If a student is required to

pay a comprehensive fee to an eligible educational institution that

includes charges for tuition, fees, and personal expenses described in

paragraph (d)(3) of this section, the portion of the comprehensive fee

that is allocable to personal expenses is not a qualified tuition and

related expense. The allocation must be made by the institution using a

reasonable method.

(5) Hobby courses. Qualified tuition and related expenses do not

include expenses that relate to any course of instruction or other

education that involves sports, games, or hobbies, or any noncredit

course, unless the course 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.

(6) Examples. The following examples illustrate the rules of this

paragraph (d). In each example, assume that all other relevant

requirements to claim an education credit are met. The examples are as

follows:

Example 1. University V offers a degree program in dentistry. In

addition to tuition, all students enrolled in the program are

required to pay a fee to University V for the rental of dental

equipment. Because the equipment rental fee must be paid to

University V for enrollment and attendance, the tuition and the

equipment rental fee are qualified tuition and related expenses.

Example 2. First-year students at College W are required to

obtain books and other reading materials used in its mandatory

first-year curriculum. The books and other reading materials are not

required to be purchased from College W and may be borrowed from

other students or purchased from off-campus bookstores, as well as

from College W's bookstore. College W bills students for any books

and materials purchased from College W's bookstore. The fee that

College W charges for the first-year books and materials purchased

at its bookstore is not a qualified tuition and related expense

because the books and materials are not required to be purchased

from College W for enrollment or attendance at the institution.

Example 3. All students who attend College X are required to pay

a separate student activity fee in addition to their tuition. The

student activity fee is used solely to fund on-campus organizations

and activities run by students, such as the student newspaper and

the student government (no portion of the fee covers personal

expenses). Although labeled as a student activity fee, the fee is

required for enrollment or attendance at College X. Therefore, the

fee is a qualified tuition and related expense.

Example 4. The facts are the same as in Example 3, except that

College X offers an optional athletic fee that students may pay to

receive discounted tickets to sports events. The athletic fee is not

required for enrollment or attendance at College X. Therefore, the

fee is not a qualified tuition and related expense.

Example 5. College Y requires all students to live on campus. It

charges a single comprehensive fee to cover tuition, required fees

not allocable to personal expenses, and room and board. Based on

College Y's reasonable allocation, sixty percent of the

comprehensive fee is allocable to tuition and other required fees

not allocable to personal expenses, and the remaining forty percent

of the comprehensive fee is allocable to charges for room and board.

Therefore, only sixty percent of College Y's comprehensive fee is a

qualified tuition and related expense.

Example 6. As a degree student at College Z, Student A is

required to take a certain number of courses outside of her chosen

major in Economics. To fulfill this requirement, Student A enrolls

in a square dancing class offered by the Physical Education

Department. Because Student A receives credit toward her degree

program for the square dancing class, the tuition for the square

dancing class is included in qualified tuition and related expenses.

Sec. 1.25A-3 Hope Scholarship Credit.

(a) Amount of the credit--(1) In general. Subject to the phase out

of the education credit described in Sec. 1.25A-1(c), the Hope

Scholarship Credit amount is the total of--

(i) 100 percent of the first $1,000 of qualified tuition and

related expenses

[[Page 801]]

paid during the taxable year for education furnished to an eligible

student (as defined in paragraph (d) of this section) who is the

taxpayer, the taxpayer's spouse, or any claimed dependent during any

academic period beginning in the taxable year (or treated as beginning

in the taxable year, see Sec. 1.25A-5(e)(2)); plus

(ii) 50 percent of the next $1,000 of such expenses paid with

respect to that student.

(2) Maximum credit. For taxable years beginning before 2002, the

maximum Hope Scholarship Credit allowed for each eligible student is

$1,500. For taxable years beginning after 2001, the amounts in

paragraph (a)(1) of this section to determine the maximum credit will

be increased for inflation occurring after 2000 in accordance with

section 1(f)(3). If any amount adjusted under this paragraph (a)(2) is

not a multiple of $100, the amount will be rounded to the next lowest

multiple of $100.

(b) Per student credit--(1) In general. A Hope Scholarship Credit

may be claimed for the qualified tuition and related expenses of each

eligible student (as defined in paragraph (d) of this section).

(2) Example. The following example illustrates the rule of this

paragraph (b). In the example, assume that all the requirements to

claim an education credit are met. The example is as follows:

Example. In 1999, Taxpayer A has two dependents, B and C, both

of whom are eligible students. Taxpayer A pays $1,600 in qualified

tuition and related expenses for dependent B to attend a community

college. Taxpayer A pays $5,000 in qualified tuition and related

expenses for dependent C to attend University X. Taxpayer A may

claim a Hope Scholarship Credit of $1,300 ($1,000 + (.50 x $600))

for dependent B, and the maximum $1,500 Hope Scholarship Credit for

dependent C, for a total Hope Scholarship Credit of $2,800.

(c) Credit allowed for only two taxable years. For each eligible

student, the Hope Scholarship Credit may be claimed for no more than

two taxable years.

(d) Eligible student--(1) Eligible student defined. For purposes of

the Hope Scholarship Credit, the term eligible student means a student

who satisfies all of the following requirements--

(i) Degree requirement. For at least one academic period that

begins during the taxable year, the student enrolls at an eligible

educational institution in a program leading toward a postsecondary

degree, certificate, or other recognized postsecondary educational

credential;

(ii) Work load requirement. For at least one academic period that

begins during the taxable year, the student enrolls for at least half

of the normal full-time work load for the course of study the student

is pursuing. The standard for what is half of the normal full-time work

load is determined by each eligible educational institution. However,

the standard for half-time may not be lower than standards for half-

time established by the Department of Education under the Higher

Education Act of 1965 and set forth in 34 CFR 674.2(b) for a half-time

undergraduate student;

(iii) Year of study requirement. As of the beginning of the taxable

year, the student has not completed the first two years of

postsecondary education at an eligible educational institution. Whether

a student has completed the first two years of postsecondary education

at an eligible educational institution as of the beginning of a taxable

year is determined based on whether the institution in which the

student is enrolled in a degree program (as described in paragraph

(d)(1)(i) of this section) awards the student two years of academic

credit at that institution for postsecondary course work completed by

the student prior to the beginning of the taxable year. Any academic

credit awarded by the eligible educational institution solely on the

basis of the student's performance on proficiency examinations is

disregarded in determining whether the student has completed two years

of postsecondary education; and

(iv) No felony drug conviction. The student has not been convicted

of a federal or state felony offense for possession or distribution of

a controlled substance as of the end of the taxable year for which the

credit is claimed.

(2) Examples. The following examples illustrate the rules of this

paragraph (d). In each example, assume that the student has not been

convicted of a felony drug offense, that the institution is an eligible

educational institution unless otherwise stated, that the qualified

tuition and related expenses are paid during the same taxable year that

the academic period begins, and that a Hope Scholarship Credit has not

previously been claimed for the student (see paragraph (c) of this

section). The examples are as follows:

Example 1. Student A graduates from high school in June 1998 and

enrolls full-time in an undergraduate degree program at College U

for the 1998 Fall semester. For the 1999 Spring semester, Student A

again enrolls at College U on a full-time basis. For the 1999 Fall

semester, Student A enrolls in less than half the normal full-time

course work for her degree program. Because Student A is enrolled in

an undergraduate degree program on at least a half-time basis for at

least one academic period that begins during 1998 and at least one

academic period that begins during 1999, Student A is an eligible

student for taxable years 1998 and 1999 (including the 1999 Fall

semester when Student A enrolls at College U on less than a half-

time basis).

Example 2. Prior to 1998, Student B attended college for several

years on a full-time basis. Student B transfers to College V for the

1998 Spring semester. College V awards Student B credit for some

(but not all) of the courses he previously completed, and College V

classifies Student B as a first-semester sophomore. During both the

Spring and Fall semesters of 1998, Student B enrolls in half the

normal full-time work load for his degree program. Because College V

does not classify Student B as having completed the first two years

of postsecondary education as of the beginning of 1998, Student B is

an eligible student for taxable year 1998.

Example 3. The facts are the same as in Example 2. After taking

classes on a half-time basis for the 1998 Spring and Fall semesters,

Student B enrolls in a full-time work load at College V for the 1999

Spring semester. College V classifies Student B as a second-semester

sophomore for the 1999 Spring semester and as a first-semester

junior for the 1999 Fall semester. Because College V does not

classify Student B as having completed the first two years of

postsecondary education as of the beginning of 1999, Student B is an

eligible student for taxable year 1999.

Example 4. At the time that Student C enrolls in a degree

program at College W for the 1998 Fall semester, Student C takes

examinations to demonstrate her proficiency in several subjects. On

the basis of Student C's performance on these examinations, College

W classifies Student C as a second-semester sophomore as of the

beginning of the 1998 Fall semester. Student C takes a full-time

work load during the 1998 Fall semester and during the 1999 Spring

and Fall semesters. Because Student C was not enrolled in a college

or other eligible educational institution prior to 1998 (but rather

was classified as a second-semester sophomore by College W as of the

start of the 1998 Fall semester solely because of proficiency

examinations), Student C is not treated as having completed the

first two years of postsecondary education at an eligible

educational institution as of the beginning of 1998 or as of the

beginning of 1999. Therefore, Student C is an eligible student for

both taxable years 1998 and 1999.

Example 5. During the 1998 Fall semester, Student D is a high

school student who takes classes on a half-time basis at College X.

Student D is not enrolled as part of a degree program at College X

because College X does not admit students to a degree program unless

the student has a high school diploma or equivalent. Because Student

D is not enrolled in a degree program at College X during 1998,

Student D is not an eligible student for taxable year 1998.

Example 6. The facts are the same as in Example 5. During the

1999 Spring semester,

[[Page 802]]

Student D again attends College X but not as part of a degree

program. Student D graduates from high school in June 1999. For the

1999 Fall semester, Student D enrolls in College X as part of a

degree program, and College X awards Student D credit for her prior

course work at College X.

During the 1999 Fall semester, Student D takes more than half

the normal full-time work load of courses for her degree program at

College X. Because Student D is enrolled in a degree program at

College X for the 1999 Fall term on more than a half-time basis,

Student D is an eligible student for all of taxable year 1999.

Therefore, the qualified tuition and required fees paid for

classes taken at College X during both the 1999 Spring semester

(during which Student D was not enrolled in a degree program) and

the 1999 Fall semester are taken into account in computing any Hope

Scholarship Credit.

Example 7. Student E completed two years of undergraduate study

at College S located in Country S. College S is not an eligible

educational institution for purposes of the education credits. At

the end of 1998, Student E moves to the United States and enrolls in

an undergraduate degree program at College Z on a full-time basis

for the 1999 Spring semester. College Z awards Student E two years

of academic credit for his previous course work at College S and

classifies Student E as a first-semester junior for the 1999 Spring

semester. Student E is treated as having completed the first two

years of postsecondary education at an eligible educational

institution as of the beginning of 1999. Therefore, Student E is not

an eligible student for taxable year 1999.

Example 8. Student F was born and raised in Country R, and she

received a degree in 1998 from College R located in Country R.

College R is not an eligible educational institution for purposes of

the education credits. During 1999, Student F moves to the United

States and enrolls for the 1999 Fall semester on a full-time basis

in a graduate-degree program at College Y. By admitting Student F to

its graduate degree program, College Y treats Student F as having

completed the first two years of postsecondary education as of the

beginning of 1999. Therefore, Student F is not an eligible student

for taxable year 1999.

(e) Academic period for prepayments--(1) In general. For purposes

of determining whether a student meets the requirements in paragraph

(d) of this section for a taxable year, if qualified tuition and

related expenses are paid during one taxable year for an academic

period that begins during January, February or March of the next

taxable year (for taxpayers on a fiscal taxable year, use the first

three months of the next taxable year), the academic period is treated

as beginning during the taxable year in which the payment is made.

(2) Example. The following example illustrates the rule of this

paragraph (e). In the example, assume that all the requirements to

claim a Hope Scholarship Credit are met. The example is as follows:

Example. Student G graduates from high school in June 1998.

After graduation, Student G works full-time for several months to

earn money for college. Student G enrolls full-time in an

undergraduate degree program at University W, an eligible

educational institution, for the 1999 Spring semester, which begins

in January 1999. Student G pays tuition to University W for the 1999

Spring semester in December 1998. Because the tuition paid by

Student G in 1998 relates to an academic period that begins during

the first three months of 1999, Student G's eligibility to claim a

Hope Scholarship Credit in 1998 is determined as if the 1999 Spring

semester began in 1998. Thus, assuming Student G has not been

convicted of a felony drug offense as of December 31, 1998, Student

G is an eligible student for 1998.

(f) Effective date. The Hope Scholarship Credit is applicable for

qualified tuition and related expenses paid after December 31, 1997,

for education furnished in academic periods beginning after December

31, 1997.

Sec. 1.25A-4 Lifetime Learning Credit.

(a) Amount of the credit--(1) Taxable years beginning before

January 1, 2003. Subject to the phase out of the education credit

described in Sec. 1.25A-1(c), for taxable years beginning before 2003,

the Lifetime Learning Credit amount is 20 percent of up to $5,000 of

qualified tuition and related expenses paid during the taxable year for

education furnished to the taxpayer, the taxpayer's spouse, and any

claimed dependent during any academic period beginning in the taxable

year (or treated as beginning in the taxable year, see Sec. 1.25A-

5(e)(2)).

(2) Taxable years beginning after December 31, 2002. Subject to the

phase out of the education credit described in Sec. 1.25A-1(c), for

taxable years beginning after 2002, the Lifetime Learning Credit amount

is 20 percent of up to $10,000 of qualified tuition and related

expenses paid during the taxable year for education furnished to the

taxpayer, the taxpayer's spouse, and any claimed dependent during any

academic period beginning in the taxable year (or treated as beginning

in the taxable year, see Sec. 1.25A-5(e)(2)).

(3) Coordination with the Hope Scholarship Credit. Expenses paid

with respect to a student for whom the Hope Scholarship Credit is

claimed are not eligible for the Lifetime Learning Credit.

(4) Examples. The following examples illustrate the rules of this

paragraph (a). In each example, assume that all the requirements to

claim a Lifetime Learning Credit or a Hope Scholarship Credit, as

applicable, are met. The examples are as follows:

Example 1. In 1999, Taxpayer A pays qualified tuition and

related expenses of $3,000 for dependent B to attend an eligible

educational institution, and he pays qualified tuition and related

expenses of $4,000 for dependent C to attend an eligible educational

institution. Taxpayer A does not claim a Hope Scholarship Credit

with respect to either B or C. Although Taxpayer A paid $7,000 of

qualified tuition and related expenses during the taxable year,

Taxpayer A may claim the Lifetime Learning Credit with respect to

only $5,000 of such expenses. Therefore, the maximum Lifetime

Learning Credit Taxpayer A may claim for 1999 is $1,000 (.20 x

$5,000).

Example 2. In 1999, Taxpayer D pays $6,000 of qualified tuition

and related expenses for dependent E, and $2,000 of qualified

tuition and related expenses for dependent F, to attend eligible

educational institutions. Dependent F has already completed the

first two years of postsecondary education. For 1999, Taxpayer D

claims the maximum $1,500 Hope Scholarship Credit with respect to

dependent E. In computing the amount of the Lifetime Learning

Credit, Taxpayer D may not include any of the $6,000 of qualified

tuition and related expenses paid on behalf of dependent E but may

include the $2,000 of qualified tuition and related expenses of

dependent F.

0(b) Credit allowed for unlimited number of taxable years. There is

no limit to the number of taxable years that a taxpayer may claim a

Lifetime Learning Credit with respect to any student.

(c) Both degree and nondegree courses are eligible for the credit--

(1) In general. For purposes of the Lifetime Learning Credit, amounts

paid for a course at an eligible educational institution are qualified

tuition and related expenses if the course is either part of a

postsecondary degree program or is not part of a postsecondary degree

program but is taken by the student to acquire or improve job skills.

(2) Examples. The following examples illustrate the rule of this

paragraph (c). In each example, assume that all the requirements to

claim a Lifetime Learning Credit are met. The examples are as follows:

Example 1. Taxpayer A, a professional photographer, enrolls in

an advanced photography course at a local community college.

Although the course is not part of a degree program, Taxpayer A

enrolls in the course to improve her job skills. The course fee paid

by Taxpayer A is a qualified tuition and related expense for

purposes of the Lifetime Learning Credit.

Example 2. Taxpayer B, a stockbroker, plans to travel abroad on

a ``photo-safari'' for his next vacation. In preparation for the

trip, Taxpayer B enrolls in a noncredit photography class at a local

community college. Because Taxpayer B is not taking the

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photography course as part of a degree program or to acquire or

improve his job skills, amounts paid by Taxpayer B for the course

are not qualified tuition and related expenses for purposes of the

Lifetime Learning Credit.

(d) Effective date. The Lifetime Learning Credit is applicable for

qualified tuition and related expenses paid after June 30, 1998, for

education furnished in academic periods beginning after June 30, 1998.

Sec. 1.25A-5 Special rules relating to characterization and timing of

payments.

(a) Payments of educational expenses by a third party--(1) In

general. Solely for purposes of section 25A, if a third party (someone

other than the taxpayer, the taxpayer's spouse, or a claimed dependent)

makes a payment directly to an eligible educational institution to pay

for a student's qualified tuition and related expenses, the student is

treated as receiving the payment from the third party, and, in turn,

paying the qualified tuition and related expenses to the institution.

(2) Example. The following example illustrates the rule of this

paragraph (a). In the example, assume that all the requirements to

claim an education credit are met. The example is as follows:

Example. Grandparent D makes a direct payment to an eligible

educational institution for Student E's qualified tuition and

related expenses. Student E is not a claimed dependent in 1999. For

purposes of claiming an education credit, Student E is treated as

receiving the money from her grandparent and, in turn, paying her

qualified tuition and related expenses.

(b) Expenses paid by dependent--(1) In general. Qualified tuition

and related expenses paid by a student are treated as paid by a

taxpayer if the student is a claimed dependent of the taxpayer for the

taxable year in which the expenses are paid.

(2) Example. The following example illustrates the rule of this

paragraph (b). In the example, assume that all the requirements to

claim an education credit are met. The example is as follows:

Example. Under a court-approved divorce decree, Parent A is

required to pay Student C's college tuition. Parent A makes a direct

payment to an eligible educational institution for Student C's 1999

tuition. Under paragraph (a) of this section, Student C is treated

as receiving the money from Parent A and, in turn, paying his

qualified tuition and related expenses. Under the divorce decree,

Parent B has custody of Student C for 1999. Parent B properly claims

Student C as a dependent on Parent B's 1999 federal income tax

return. Parent B may claim an education credit for the qualified

tuition and related expenses paid directly to the institution by

Parent A.

(c) Adjustment to qualified tuition and related expenses for

certain excludable educational assistance--(1) In general. In

determining the amount of an education credit, qualified tuition and

related expenses paid during the taxable year must be reduced by any

amount paid to, or on behalf of, a student during the taxable year with

respect to attendance at an eligible educational institution during an

academic period beginning in that taxable year that is--

(i) A qualified scholarship that is excludable from income under

section 117;

(ii) A veterans' or member of the armed forces' educational

assistance allowance under chapter 30, 31, 32, 34 or 35 of title 38,

United States Code, or under chapter 1606 of title 10, United States

Code;

(iii) Employer-provided educational assistance that is excludable

from income under section 127; or

(iv) Any other educational assistance that is excludable from gross

income (other than as a gift, bequest, devise, or inheritance within

the meaning of section 102(a)).

(2) No adjustment for excludable educational assistance

attributable to expenses paid in a prior year. A reduction is not

required under paragraph (c)(1) of this section if the amount of

excludable educational assistance received during the taxable year is

treated as a refund of qualified tuition and related expenses paid in a

prior taxable year. See paragraph (f)(4) of this section.

(3) Allocation of scholarships and fellowship grants. For purposes

of paragraph (c)(1) of this section, a scholarship or fellowship grant

is treated as a qualified scholarship excludable from income under

section 117 unless--

(i) The student reports the grant as income on the student's

federal income tax return; or

(ii) The grant must be applied, by its terms, to expenses other

than qualified tuition and related expenses within the meaning of

section 117(b)(2), such as room and board.

(4) Examples. The following examples illustrate the rules of this

paragraph (c). In each example, assume that all the requirements to

claim an education credit are met. The examples are as follows:

Example 1. University X charges Student A, who lives on X's

campus, $3,000 for tuition and $5,000 for room and board. University

X awards a $2,000 scholarship to Student A, which University X

applies against Student A's $8,000 total bill. The terms of the

scholarship permit it to be used to pay any of a student's costs of

attendance at University X, including tuition and room and board.

Student A pays the $6,000 balance of her bill from University X with

a combination of savings and amounts she earns from a summer job.

University X does not require A to pay any additional fees beyond

the $3,000 in tuition in order to enroll in classes. Student A does

not report any portion of the scholarship as income on Student A's

federal income tax return. The scholarship is a qualified

scholarship that is excludable from Student A's income under section

117 and is allocable first to Student A's qualified tuition and

related expenses. Therefore, for purposes of calculating an

education credit, Student A is treated as having paid only $1,000

($3,000 tuition -$2,000 scholarship) in qualified tuition and

related expenses to University X.

Example 2. The facts are the same as in Example 1, except that

in addition to the scholarship that University X awards to Student

A, University X also provides Student A with a student loan and pays

Student A for working in a work/study job in the campus dining hall.

The loan is not excludable educational assistance. In addition,

wages paid to a student who is performing services for the payor are

neither a qualified scholarship nor otherwise excludable from gross

income. Therefore, Student A is not required to reduce her qualified

tuition and related expenses by the amounts she receives from the

student loan or as wages from her work/study job.

Example 3. In 1999, Student B pays University Y $1,000 in

tuition for the 1999 Spring semester. University Y does not require

Student B to pay any additional fees beyond the $1,000 in tuition in

order to enroll in classes. Student B is an employee of Company Z.

At the end of the academic period and during the same taxable year

that Student B paid tuition to University Y, Student B provides

Company Z with proof that he has satisfactorily completed his

courses at University Y. Pursuant to an educational assistance

program described in section 127(b), Company Z reimburses Student B

for all of the tuition paid to University Y. Because the

reimbursement from Company Z is employer-provided educational

assistance that is excludable from Student B's gross income under

section 127, the reimbursement reduces Student B's qualified tuition

and related expenses. Therefore, for purposes of calculating an

education credit, Student B is treated as having paid no qualified

tuition and related expenses to University Y during 1999.

Example 4. The facts are the same as in Example 3, except that

the reimbursement from Company Z is not pursuant to an educational

assistance program described in section 127(b), is not otherwise

excludable from Student B's gross income, and is taxed as additional

wages to Student B. Because the reimbursement is not excludable

employer-provided educational assistance, Student B is not required

to reduce his qualified tuition and related expenses by the $1,000

reimbursement he received from his

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employer. Therefore, for purposes of calculating an education

credit, Student B is treated as paying $1,000 in qualified tuition

and related expenses to University Y during 1999.

(d) No double benefit. Qualified tuition and related expenses do

not include any expense for which a deduction is allowed under section

162 or any other provision of chapter 1 of the Internal Revenue Code.

(e) Timing rules--(1) In general. Except as provided in paragraph

(e)(2) of this section, an education credit is allowed only for

payments of qualified tuition and related expenses for an academic

period beginning in the same taxable year as the year the payment is

made. Except for certain individuals who do not use the cash receipts

and disbursements method of accounting, qualified tuition and related

expenses are treated as paid in the year in which the expenses are

actually paid. See Sec. 1.461-1(a)(1).

(2) Prepayment rule--(i) In general. If qualified tuition and

related expenses are paid during one taxable year for an academic

period that begins during the first three months of the taxpayer's next

taxable year (i.e., in January, February, or March of the next taxable

year for calendar year taxpayers), an education credit is allowed with

respect to the qualified tuition and related expenses only in the

taxable year in which the expenses are paid.

(ii) Example. The following example illustrates the rule of this

paragraph (e)(2). In the example, assume that all the requirements to

claim an education credit are met. The example is as follows:

Example. In December 1998, Taxpayer A, a calendar year taxpayer,

pays College Z $1,000 in qualified tuition and related expenses to

attend the 1999 Spring semester, which begins in January 1999.

Taxpayer A may claim an education credit only in 1998 for payments

made in 1998 for the 1999 Spring semester.

(3) Expenses paid with loan proceeds. An education credit may be

claimed for the qualified tuition and related expenses paid with the

proceeds of a loan only in the taxable year in which the expenses are

paid, and may not be claimed in the taxable year in which the loan is

repaid. Loan proceeds disbursed directly to an eligible educational

institution will be treated as paid on the date of disbursement. If a

taxpayer does not know the date of disbursement, the taxpayer must

treat the qualified tuition and related expenses as paid on the last

date for payment prescribed by the institution.

(f) Refund of qualified tuition and related expenses--(1) Payment

and refund of qualified tuition and related expenses in the same

taxable year. With respect to any student, the amount of qualified

tuition and related expenses for a taxable year is calculated by adding

all qualified tuition and related expenses paid for the taxable year,

and subtracting any refund of such expenses received from the eligible

educational institution during the same taxable year.

(2) Payment of qualified tuition and related expenses in one

taxable year and refund in subsequent taxable year before return filed

for prior taxable year. If, in a taxable year, a taxpayer, (or the

taxpayer's spouse or a claimed dependent) receives a refund from an

eligible educational institution of qualified tuition and related

expenses paid in a prior taxable year and the refund is received before

the taxpayer files a federal income tax return for the prior taxable

year, the amount of the qualified tuition and related expenses for the

prior taxable year is reduced by the amount of the refund.

(3) Payment of qualified tuition and related expenses in one

taxable year and refund in subsequent taxable year--(i) In general. If,

in a taxable year (refund year), a taxpayer (or the taxpayer's spouse

or a claimed dependent) receives a refund of qualified tuition and

related expenses for which the taxpayer claimed an education credit in

a prior taxable year, the tax imposed by chapter 1 of the Internal

Revenue Code for the refund year is increased by the recapture amount.

(ii) Recapture amount. The recapture amount is the difference

between the credit claimed in the prior taxable year and the

redetermined credit. The redetermined credit is computed by reducing

the amount of the qualified tuition and related expenses for which a

credit was claimed in the prior taxable year by the amount of the

refund of the qualified tuition and related expenses (redetermined

qualified expenses), and computing the credit using the redetermined

qualified expenses and the relevant facts and circumstances of the

prior taxable year, such as modified adjusted gross income

(redetermined credit). Any redetermination of the tax liability for the

prior taxable year (by audit or amended return) will be taken into

account in computing the redetermined credit.

(4) Excludable educational assistance received in a subsequent

taxable year treated as a refund. If, in a taxable year, any excludable

educational assistance (described in paragraph (c)(1) of this section)

is received for the qualified tuition and related expenses paid during

a prior taxable year (or attributable to enrollment at an eligible

educational institution during a prior taxable year), the educational

assistance is treated as a refund of qualified tuition and related

expenses for purposes of paragraphs (f)(2) and (3) of this section. If

a taxpayer (or the taxpayer's spouse or a claimed dependent) receives

any excludable educational assistance before the taxpayer files a

federal income tax return for the prior taxable year, the amount of the

qualified tuition and related expenses for the prior taxable year is

reduced by the amount of the excludable educational assistance as

provided in paragraph (f)(2) of this section. If a taxpayer (or the

taxpayer's spouse or a claimed dependent) receives excludable

educational assistance after the taxpayer has filed a federal income

tax return for the prior taxable year, any education credit claimed for

the prior taxable year is subject to recapture as provided in paragraph

(f)(3) of this section.

(5) Examples. The following examples illustrate the rules of this

paragraph (f). In each example, assume that all the requirements to

claim an education credit are met. The examples are as follows:

Example 1. In January 1998, Student A, a full-time freshman at

University X, pays $2,000 for qualified tuition and related expenses

for a 16-hour work load for the 1998 Spring semester. Prior to

beginning classes, Student A withdraws from 6 course hours. On

February 15, 1998, Student A receives an $800 refund from University

X. In September 1998, Student A pays University X $1,000 to enroll

half-time for the 1998 Fall semester. Prior to beginning classes,

Student A withdraws from a 2-hour course, and she receives a $200

refund in October 1998. Student A computes the amount of qualified

tuition and related expenses she may claim for 1998 by:

(i) Adding all qualified expenses paid during the taxable year

($2,000 + 1,000 = $3,000);

(ii) Adding all refunds of qualified tuition and related

expenses received during the taxable year ($800 + $200 = $1,000);

and, then

(iii) Subtracting (ii) from (i) ($3,000--$1,000 = $2,000).

Therefore, Student A's qualified tuition and related expenses for

1998 are $2,000.

Example 2. (i) In December 1998, Student B, a senior at College

Y, pays $2,000 for qualified tuition and related expenses for a 16-

hour work load for the 1999 Spring semester. Prior to beginning

classes, Student B withdraws from a 4-hour course. On January 15,

1999, Student B files her 1998 income tax return and claims a $400

Lifetime Learning Credit for the $2,000 qualified expenses paid in

1998.

(ii) She calculates the increase in tax for 1999 by:

(A) Calculating the redetermined qualified expenses ($2,000--

$500 = $1,500);

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(B) Calculating the redetermined credit for the redetermined

qualified expenses ($1,500 x .20 = $300); and

(C) Subtracting the redetermined credit from the credit claimed

in 1998 ($400--$300 = $100).

(iii) Therefore, Student B must increase the tax on her 1999

federal income tax return by $100.

Example 3. In September 1998, Student C pays College Z $1,200 in

qualified tuition and related expenses to attend evening classes

during the 1998 Fall semester. Student C is an employee of Company

R. On January 15, 1999, Student C files a federal income tax return

for 1998 claiming a Lifetime Learning Credit of $240 (.20 x

$1,200). Pursuant to an educational assistance program described in

section 127(b), Company R reimburses Student C in February 1999 for

the $1,200 of qualified tuition and related expenses paid by Student

C in 1998. The $240 education credit claimed by Student C for 1998

is subject to recapture. Because Student C paid no net qualified

tuition and related expenses in 1998, the redetermined credit for

1998 is zero. Student C must increase the amount of Student C's 1999

taxes by the recapture amount, which is $240 (the education credit

claimed for 1998 ($240) minus the redetermined credit for 1998

($0)). Because the $1,200 reimbursement is taken into account in

calculating the $240 recapture amount for 1999, the reimbursement

does not reduce the amount of any qualified tuition and related

expenses that Student C paid in 1999.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 99-177 Filed 1-5-99; 8:45 am]

BILLING CODE 4830-01-U