[Federal Register Volume 64, Number 3 (Wednesday, January 6, 1999)]
[Proposed Rules]
[Pages 794-805]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-177]


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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

[[Page 803]]

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

[[Page 804]]

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);

[[Page 805]]

    (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