Order Code RL31129
Higher Education Tax Credits and Deduction:
An Overview of the Benefits and Their
Relationship to Traditional Student Aid
Updated January 5, 2007
Linda Levine
Specialist in Labor Economics
Domestic Social Policy Division
Adam Stoll
Specialist in Social Legislation
Domestic Social Policy Division

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Higher Education Tax Credits and Deduction:
An Overview of the Benefits and Their
Relationship to Traditional Student Aid
Summary
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 of 2006.
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 incentives.
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 rose to a maximum of $1,650 per student for tax year 2006; 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 2006, 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. This report
will be updated as warranted.

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Contents
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
The Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Middle-Income Families . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Traditional and Nontraditional Students . . . . . . . . . . . . . . . . . . . . . . . . 8
The Education Tax Benefits’ Relative Worth . . . . . . . . . . . . . . . . . . . . . . . . 9
Benefit Size and Tax Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Benefit Size and Qualified Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Relationship of Education Tax Benefits
to the Traditional Student Aid Delivery System . . . . . . . . . . . . . . . . . . . . . 13
Strengths and Weaknesses of the Approaches . . . . . . . . . . . . . . . . . . . . . . . 13
Direct Effect of Tax Benefits on Traditional Student Aid . . . . . . . . . . . . . . 14
Effect on Federal Student Aid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Effect on Packaging of Other Aid . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Effect on State Decisions Related to Tuition Levels
and Available Sources of Aid . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
List of Tables
Table 1. Major Features of the Higher Education Tax Credits
and Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Table 2. Preliminary 2004 IRS Data for the Hope and
Lifetime Learning Credits and the Higher Education Deduction . . . . . . . . . 8
Table 3. Examples of Tax Savings
from the Higher Education Tax Credits and Deduction . . . . . . . . . . . . . . . 10

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Higher Education Tax Credits
and Deduction: An Overview of
the Benefits and Their Relationship
to Traditional Student Aid
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 2002. It was
extended to December 31, 2007 in the Tax Relief and Health Care Act of 2006 (P.L.
109-432).1
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 $13 billion in grant aid for FY2006) and the Federal Family
Education Loan and Direct Loan programs (an estimated $60.6 billion in new loan
volume for FY2006).2
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. Preliminary data from the Internal Revenue Service (IRS) show that
taxpayers took $6.1 billion in education tax credits and $10.7 billion in higher
education deductions on their 2004 federal income tax returns.3
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
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 Internal Revenue Service, “Individual Income Tax Returns, Preliminary Data, 2004,”
Statistics of Income Bulletin, winter 2005-2006. (Hereafter cited as IRS, Individual Income
Tax Returns, Preliminary Data, 2004.)

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CRS-2
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 students’ financial need.4
Finally, a significant portion of this assistance is subject to annual appropriations.
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 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.
An Overview of the Benefits
The Hope Scholarship Credit
The Hope Scholarship credit is a nonrefundable credit against federal income
tax liability for qualified higher education expenses.5 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. Although the
$1,000 figures became indexed to inflation after 2001, the formula specified in the
TRA for this purpose did not result in the Hope credit’s maximum value rising until
tax year 2006 (i.e., 100% of the first $1,100 in qualified expenses and 50% of the
second $1,100 = $1,650 per student).
Taxpayers can claim the credit for qualified higher education expenses of each
eligible student for whom they claim tax exemptions, including themselves, their
spouse, and dependent children.6 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
4 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, Feb. 2001, p. 8.) The Committee reports that 18.6% of state grant aid funds
is now merit-based.
5 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.
6 Expenses paid by a dependent or someone other than the filer, spouse, or dependent are
treated as if paid by the taxpayer.

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CRS-3
finished the first two years of undergraduate education, and the credit can only be
claimed for their first two years of study.7 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 gross income8 for 2006 is between $45,000 and $55,000 (for those
filing joint returns, between $90,000 and $110,000). 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
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
7 The first two years of postsecondary education can include two one-year certificate
programs. See 67 Federal Register 76687 (Dec. 26, 2002), where the Hope and Lifetime
Learning credits’ final regulations are published.
8 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 those excluded amounts.

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CRS-4
qualified expenses. Unlike the Hope credit, the value of the Lifetime Learning credit
is not adjusted for inflation.9
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 phase-out
ranges.
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.
The Higher Education Deduction
The above-the-line deduction for taxpayers who pay qualified higher education
expenses for eligible students became effective in 2002.10 After expiring on January
1, 2006, it was reauthorized retroactive to its expiration and to December 31, 2007.
For 2006, the maximum deduction is $4,000 per return.11 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 $130,000 but not more
than $160,000 for those filing joint returns).12 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.
9 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 most.
10 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.
11 For 2002 and 2003, it was set at $3,000 per return.
12 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
deduction.

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CRS-5
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
The credit reduces income tax liability. It is referred
Same
The deduction reduces taxable income. It is
tax benefit
to as a “nonrefundable credit” because it can only be
referred to as an “above-the-line” deduction
claimed by individuals who have tax liabilities
because it is claimed as an adjustment to
remaining after they have taken personal/dependency
income on the 1040 form, and therefore is
exemptions, standard or itemized deductions, and
available to taxpayers who do not itemize
other personal credits. As a result, the taxpayer may
deductions. The actual value of the
not be able to realize the full value of the Hope
deduction depends on the taxpayer’s
Credit.
marginal tax rate. Generally, the higher the
tax rate, the larger the deduction.
Who can claim
Taxpayers who claim an exemption on their returns
Same
Same
it?
for a student with qualified higher education
expenses (e.g., a child, a spouse, or themselves).
For whom can it
A student enrolled at least half-time for at least one
A student enrolled in one or more
Same as Life Learning Credit
be claimed?
academic period in a program leading to an
courses at the undergraduate level or
educational credential at an eligible educational
graduate level at an eligible educational
institution, who is in their first two years of
institution who need not be pursuing an
postsecondary school and who has not had a felony
educational credential.
drug conviction. The credit is available for two
years per student.
Qualified
Tuition and related expenses required for enrollment
Same
Same
expenses
or attendance at an eligible educational institution.
These expenses must be reduced by any tax-free
Same
Same
educational assistance (e.g., Pell Grants,
scholarships, Veterans’ educational assistance, and
employer-provided educational benefits).
Eligible
Any college, university, vocational school, or other
Same
Same
institutions
postsecondary institution eligible to participate in an
ED-administered student aid program.
Maximum value
$1,650 per student in tax year 2006.
$2,000 per return in tax year 2006.
$4,000 per return in tax year 2006.
of the benefit
(100% of the first $1,100 of qualified expenses and
(20% of the first $10,000 of qualified
50% of the second $1,100 per student. Each of the
expenses per return.)

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CRS-6
Characteristic
Hope Scholarship Credit
Lifetime Learning Credit
Higher Education Deduction
dollar amounts is indexed for inflation annually.)
Income
Taxpayers whose AGI is $55,000 or more ($110,000
Same
The $4,000 deduction is not available to
eligibility limits
or more for those filing joint returns) are not eligible
taxpayers whose AGI is more than $65,000
for the credit in tax year 2006. The credit amount is
(more than $130,000 for those filing joint
gradually reduced for taxpayers whose AGI is
returns). Persons with AGIs of more than
between $45,000 and $55,000 ($90,000 and $110,000
$65,000 but not more than $80,000 (more
for those filing joint returns). The income ranges are
than $130,000 but not more than $160,000
adjusted annually for inflation.
for joint filers) are eligible for a lower
maximum of $2,000. There is no phase-out,
and the income threshold is not indexed for
inflation.
Coordination of
The Hope Credit cannot be claimed if the Lifetime
Same
Same
benefits (i.e., no
Learning Credit, Tuition and Fees Deduction, or
double benefit
business expense deduction is taken for the same
allowed)
student in the same year.
The Hope Credit cannot be claimed for the same
Same
Same as Hope Credit except, with regard to
qualified expenses paid with tax-free educational
QTPs, the deduction could not be claimed
assistance, with tax-free withdrawals from Coverdell
for the same qualified expenses paid with
Accounts and from Section 529 Plans, and with tax-
only the tax-free earnings portion of
free interest on U.S. Savings Bonds.
withdrawals.
It can be claimed for qualified expenses paid with the
Same
Same
proceeds of a loan.
Source: 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 and
housing exclusions), which are identical for most taxpayers.

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CRS-7
Although the deduction reduces a taxpayer’s AGI dollar for dollar, it ultimately
is worth different amounts to taxpayers depending upon their marginal tax rates.13
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) in tax year 2006.
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, above, for more detail.)
Intended Beneficiaries and Benefit Size
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 recipients.14 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 Beneficiaries
Middle-Income Families. 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 recent decades.
Available data on tax benefit recipients indicate that the higher education tax
credits and deduction are, as intended, primarily serving middle- and upper middle-
13 The marginal tax rate is the tax rate applied to the last additional dollar of income.
14 For additional information see CRS Report RL33238, The Benefits of Education, by Linda
Levine.

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CRS-8
income individuals. Preliminary IRS data reveal that 36% of the 2004 tax returns
that claimed the education credits were from filers with an AGI of $50,000 or more,
and 56% of the returns that claimed the deduction were from filers in that AGI-range
as well. (See Table 2.) These tax filers accounted for 43% of the total amount
claimed in these credits, and 55% in the deduction, for 2004. In contrast, only 9%
of the returns claiming the credits, and 19% taking the deduction, were from tax filers
with an AGI of less than $15,000; these returns accounted for 3% of the total amount
of the two credits claimed and 21% of the amount of the deduction taken.
Table 2. Preliminary 2004 IRS Data for the Hope and
Lifetime Learning Credits and the Higher Education Deduction
($ in thousands)
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
Number of returns
7,253,234
641,088
1,970,286
1,986,654 2,606,261
48,945
claiming credits
% of all returns
100%
9%
27%
27%
36%
0%
claiming credits
Amount of credits
$6,076,920
$210,644 $1,420,578 $1,807,230 $2,630,920
7,550
claimed
% of total claimed
100%
3%
23%
30%
43%
0%
Number of returns
4,738,193
891,667
565,051
613,908 1,483,651
1,183,916
claiming deduction
% of all returns
100%
19%
12%
13%
31%
25%
claiming deduction
Amount of deduction $10,677,851 $2,282,676 $1,145,319 $1,285,860 $3,154,913 $2,809,082
claimed
% of total claimed
100%
21%
11%
12%
29%
26%
Source: IRS, Individual Income Tax Returns, Preliminary Data, 2004.
Note: Sum of percentages may not equal 100% due to rounding. Data are not available for each
credit individually.
Traditional and Nontraditional Students. 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

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CRS-9
many individuals who want to take courses periodically over the course of their
careers to upgrade their skills.15
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.
The Education Tax Benefits’ Relative Worth
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 additional student(s).
! 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 which benefit.
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 for tax year
2006, 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
15 Among other more narrowly targeted benefits for individuals seeking to upgrade skills is
employer education assistance.

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CRS-10
$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.
Table 3. Examples of Tax Savings
from the Higher Education Tax Credits and Deduction
Value of tax benefit per return
Higher education deduction
Hope
Lifetime
15%
25%
Tuition and
Scholarship
Learning
marginal tax
marginal tax
fees
Credit
Credit
ratea
rateb
$350
$350
$70
$53
$88
1,000
1,000
200
150
250
2,200c
1,650
440
330
550
4,000
1,650
800
600
1,000
5,500d
1,650
1,100
600
1,000
8,500
1,650
1,700
600
1,000
10,000
1,650
2,000
600
1,000
21,000e
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 $2,191 in 2005-2006,
according to The College Board, Trends in College Pricing 2005.
d. Average tuition and fees at four-year public postsecondary institution is $5,491 in 2005-2006,
according to The College Board, Trends in College Pricing 2005.
e. Average tuition and fees at four-year private postsecondary institution is $21,235 in 2005-2006,
according to The College Board, Trends in College Pricing 2005.
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

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CRS-11
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.
Benefit Size and Tax Liability. 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 tax credit beneficiaries were not able to take the full credit for
which they were eligible.”16
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
16 Bridget Terry Long, The Impact of Federal Tax Credits for Higher Education Expenses,
NBER Working Paper 9553 (Cambridge, MA: National Bureau of Economic Research,
Feb. 2003). (Hereafter cited as Long, The Impact of Federal Tax Credits.)

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marginal tax rate. Further, some taxpayers may have such limited tax liability before
the application of the deduction that its actual benefit will be small.
Benefit Size and Qualified Expenses. 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 2005-2006 that are — on average
— about that level ($2,191). 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
2005-2006 is a much lower $5,491.
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 $5,491 at
four-year public institutions in 2005-2006 is somewhat greater than the cap on
qualified expenses. In contrast, the average tuition and fees of $21,235 at four-year
private institutions in 2005-2006 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 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 2005-2006 award year, provide a maximum of $4,050 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.

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Relationship of Education Tax Benefits
to the Traditional Student Aid Delivery System
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 tax system.
Strengths and Weaknesses of the Approaches
Providing student 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 just
in advance of 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 partly 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.
While tax credits and deductions may offer the advantage of streamlined delivery
of funds to aid recipients who directly claim their financial assistance as part of their
annual tax-filing process, most other aid is delivered through relatively cumbersome
and labor-intensive processes that require considerable effort on the part of financial
aid officers, ED personnel, and loan servicers, in the case of loans, who must
collectively certify student eligibility for aid, monitor enrollment status, disburse funds,
and deal with refunds and account reconciliation. Still, some have criticized the
complexity of the process for taxpayers seeking to claim the tax benefits.17 Further,
there are institutional reporting requirements associated with the tax provisions that
initially were viewed by some in the higher education community as potentially
burdensome and expensive.18
17 See, for example Thomas R. Wolanin, Rhetoric and Reality: Effects and Consequences
of the HOPE Scholarship, The Institute for Higher Education Policy, Apr. 2001. (Hereafter
cited as Wolanin, Rhetoric and Reality.)
18 The IRS interpreted the TRA to require educational institutions to report to the IRS a
broad array of data for any individual enrolled for academic credit for whom the institution
receives tuition and fee payments. Of particular concern had been the requirement for
(continued...)

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CRS-14
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.
Direct Effect of Tax Benefits on Traditional Student Aid
Effect on Federal Student Aid. By statute, the receipt of the tax credits is to
have no effect on a student’s eligibility for, or level of, federal student aid. First, in
calculating what a student and his or her family is expected to contribute toward college
costs (expected family contribution or EFC) under the Higher Education Act (HEA)
student aid programs, HEA Section 480(a)(2) states that the tax credits cannot be
considered income or assets for purposes of that calculation. Second, HEA Section
480(j)(3) provides that the determination of need for HEA Title IV aid programs —
student’s cost of attendance minus the EFC and non-Title IV assistance — is not to include
the credits as non-Title IV assistance. Any non-Title IV assistance included in this
calculation reduces a student’s need and, hence, his or her eligibility and level of assistance
under need-based Title IV aid. 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 benefit from the deduction (i.e., have less
federal income tax liability) will, in turn, be found to have less financial need for traditional
student aid.
Tax benefits and Title IV aid may interact, however, 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 the Congress to devote funds to the
traditional federal student aid programs.
18 (...continued)
institutions to report the following for each student: the identity of the taxpayer claiming
the student as a tax dependent and the aggregate amounts of qualified expenses paid,
scholarship and grant aid received, and aggregate refunds made. Although the IRS limited
the reporting requirements in the first four years of implementation (1998-2001) to less than
those stipulated in the TRA, even these more limited requirements were criticized as costing
institutions substantial resources. P.L. 107-131 (signed into law on January 16, 2002)
modifies some of the TRA’s reporting requirements. Among other changes, it repeals the
requirement regarding reporting of information about taxpayers who can claim students as
dependents, and permits reporting of either the aggregate amounts of qualified expenses
paid or the aggregate amounts billed to students. To reflect the changes made by the
legislation, the IRS partially withdrew proposed regulations issued June 16, 2000, and
proposed new regulations on April 29, 2002 (67 Federal Register 20923).

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Effect on Packaging of Other Aid. 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 tax credits into their aid packaging
calculations may find the effort complicated by the absence of information about the
actual value of the tax benefits students will receive. As noted earlier, tax benefits
are claimed and their value known by April 15 of the year after the payment for
qualified expenses are made.
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.
Those financial aid officers who would take the tax provisions into account in
packaging aid, and thereby, reduce other kinds of aid for recipients, must make
assumptions about the benefits’ value. If gaps exist between the credits’ actual and
assumed value the recipients may receive more or less aid than intended.
Effect on State Decisions Related to Tuition Levels and Available
Sources of Aid. 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 faced by financial aid officers stemming from the hidden value of tax credits.
They must make decisions about tuition levels at state institutions and about the
structure and targeting of state aid programs which can be shaped in part by
assumptions about the value of aid that they expect will be available to students.
Precisely gauging the net financial benefit flowing from the tax benefits is
problematic; however, some states have considered, at least, raising the tuition and
fees in some schools in order to enable their 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.19 Such decisions regarding tuition and aid will affect whether and how
the tax benefits will enhance recipients’ ability to finance postsecondary education.
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19 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.)

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