[Federal Register Volume 67, Number 248 (Thursday, December 26, 2002)]
[Rules and Regulations]
[Pages 78687-78698]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-32453]



[[Page 78687]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9034]
RIN 1545-AW65


Education Tax Credit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the Hope 
Scholarship Credit and the Lifetime Learning Credit under section 25A 
of the Internal Revenue Code. The final regulations reflect changes 
made to the law by the Taxpayer Relief Act of 1997. These regulations 
provide guidance to individuals who may claim the Hope Scholarship 
Credit or the Lifetime Learning Credit for the payment of certain 
postsecondary educational expenses.

DATES: Effective Date: These regulations are effective December 26, 
2002.
    Applicability Dates: For dates of applicability, see Sec.  1.25A-
3(f) and Sec.  1.25A-4(d).

FOR FURTHER INFORMATION CONTACT: Marilyn E. Brookens, (202) 622-4920 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) 
under control number 1545-1630. Responses to this collection of 
information are mandatory.
    The collection of information 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 
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.
    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

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) regarding the Hope Scholarship Credit and the Lifetime 
Learning Credit (education tax credit) under section 25A of the 
Internal Revenue Code. The Taxpayer Relief Act of 1997 (Public Law 105-
34 (111 Stat. 788) (TRA '97)) added section 25A to provide the 
education tax credit. In general, the education tax credit allows 
taxpayers to claim a nonrefundable credit against their Federal income 
tax for the payment of certain postsecondary educational expenses. The 
Economic Growth and Tax Relief Reconciliation Act of 2001 (Public Law 
107-16 (115 Stat. 38)) added section 222 of the Internal Revenue Code 
to provide an above-the-line deduction for certain postsecondary 
education expenses paid in taxable years beginning after December 31, 
2001, and before January 1, 2006. Section 222 is an alternative to 
section 25A, and taxpayers cannot claim a section 222 deduction and a 
section 25A education tax credit in the same year with respect to the 
same student.
    On November 17, 1997, the IRS published Notice 97-60 (1997-2 C.B. 
310) to provide general guidance on the higher education tax incentives 
enacted by TRA '97, including the education tax credit. A notice of 
proposed rulemaking (REG-106388-98) was published in the Federal 
Register (64 FR 794) on January 6, 1999. One request for a public 
hearing was received. However, the request was withdrawn, and no public 
hearing was held. The IRS received written and electronic comments 
responding to the notice of proposed rulemaking. After consideration of 
all the comments, the proposed regulations are adopted as amended by 
this Treasury decision. The revisions are discussed below.

Explanation of Provisions and Summary of Comments

1. Reporting Requirements Under Section 6050S for Eligible Educational 
Institutions

    Many commentators requested clarification of the information 
reporting requirements under section 6050S for eligible educational 
institutions (institutions) that receive payments of qualified tuition 
and related expenses (qualified expenses). These comments are outside 
the scope of section 25A, which relates solely to the education tax 
credit allowable to taxpayers for payments of qualified expenses. 
However, these comments were considered by the IRS and the Treasury 
Department in drafting the proposed regulations under section 6050S 
that were published in the Federal Register (67 FR 20923) on April 29, 
2002.

2. Calculation of Education Tax Credit and General Eligibility 
Requirements

    Several commentators recommended changes to the rules for 
calculating the amount of any allowable education tax credit. One 
commentator recommended that the calculation of the Hope Scholarship 
Credit be simplified so that the credit is allowable for the first 
$1,500 of qualified expenses, rather than 100 percent of the first 
$1,000 of qualified expenses, and 50 percent of the next $1,000 of 
qualified expenses as provided in section 25A(b)(1). This commentator 
also recommended that the calculation of the Lifetime Learning Credit 
be simplified so that the credit is allowable for the first $1,000 of 
qualified expenses, rather than 20 percent of the first $5,000 of 
qualified expenses as provided in section 25A(c)(1). Another 
commentator recommended that, for purposes of the income limitations in 
section 25A(d), income realized on the conversion of a traditional 
Individual Retirement Account (IRA) to a Roth IRA should be excluded 
from the definition of modified adjusted gross income. The rules in the 
proposed regulations regarding calculation of the amount of the 
education tax credit and the definition of modified adjusted gross 
income derive from the statutory provisions of section 25A. Therefore, 
the final regulations do not adopt these recommendations.
    Commentators requested clarification of the rules for claiming the 
education tax credit in the case of a dependent. Consistent with the 
legislative history to section 25A, Sec.  1.25A-1(g) of the proposed 
regulations provides that if a student is a claimed dependent of a 
taxpayer, only that taxpayer may claim the education tax credit for the 
student's qualified expenses; however, if the taxpayer is eligible to, 
but does not claim the student as a dependent, only the student may 
claim the education tax credit for the student's qualified expenses. 
The final regulations retain this rule.

[[Page 78688]]

    Commentators asked how the student's personal exemption deduction 
amount under section 151 is calculated if a parent does not claim the 
student as a dependent on the parent's income tax return in order that 
the student may claim the education tax credit on the student's income 
tax return. Section 151(d)(2) provides a special rule for calculating 
the exemption deduction amount in the case of an individual (for 
example, a student) for whom a dependency exemption deduction is 
allowable to another taxpayer (for example, a parent). Under this rule, 
a student's personal exemption deduction amount is zero on the 
student's income tax return if a parent is eligible to claim the 
student as a dependent even if the parent does not in fact claim a 
dependency exemption deduction for the student. The result is the same 
if the amount of the dependency exemption deduction allowable to the 
parent is reduced or eliminated under the phase-out rule in section 
151(d)(3).
    Consistent with section 25A(g)(7), the proposed regulations provide 
that a nonresident alien individual is not eligible to claim an 
education tax credit, unless the individual is treated as a resident 
alien of the United States by reason of an election under section 
6013(g) or (h). One commentator suggested that Examples 7 and 8 in 
Sec.  1.25A-3(d)(2) of the proposed regulations should be revised to 
avoid any confusion about the eligibility of a nonresident alien 
student to claim an education tax credit. The final regulations modify 
these examples to avoid any implication that a nonresident alien 
student may claim an education tax credit, in the absence of an 
election under section 6013(g) or (h).
    Another commentator requested clarification as to whether a 
nonresident alien individual who elects to be treated as a resident 
alien may claim an education tax credit. A limited number of income tax 
treaties allow certain individuals to elect to be treated as residents 
of the United States. Because such an election is intended to apply for 
all tax purposes, an individual for whom a valid election under a 
treaty is in effect is treated as a resident for purposes of section 
25A.

3. Definitions

    Several commentators requested clarification of the definition of 
academic period. 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. As stated in the preamble of the proposed 
regulations, this definition 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 the Treasury Department invited comments on the proposed 
definition. One commentator suggested that the final regulations 
provide that, in the case of institutions that use clock hours or 
credit hours, but do not use traditional academic terms, the term 
academic period may include a payment period as defined by the 
Department of Education in 34 CFR 668.4. The final regulations adopt 
this recommendation.
    Several commentators requested clarification of the definition of 
qualified tuition and related expenses. The proposed regulations define 
qualified tuition and related expenses to mean tuition and fees 
required for the enrollment or attendance of a student for courses of 
instruction at an eligible educational institution. The proposed 
regulations provide that, in general, the test for determining whether 
a fee is a qualified expense is whether the fee is required to be paid 
to the institution as a condition of the student's enrollment or 
attendance at the institution. However, the proposed regulations also 
provide that qualified 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 payment 
of such fees is required for the student's enrollment or attendance. 
The final regulations retain these rules.
    One commentator requested clarification as to whether an education 
tax credit is allowable for amounts paid in one year for an independent 
study course which the student has up to two years to complete. The 
proposed regulations provide that qualified expenses paid in one 
taxable year may qualify for an education tax credit in the year of the 
payment if the expenses relate to education furnished during an 
academic period beginning in the year of payment or within the first 
three months of the next taxable year. The final regulations retain 
this rule. Therefore, an education tax credit is allowable for 
qualified expenses paid in one taxable year for independent study 
during an academic period that begins in the taxable year of payment or 
within the first three months of the next taxable year.
    One commentator requested clarification as to when amounts paid for 
books are qualified expenses. The proposed regulations provide that, in 
general, an education tax credit is not available for expenses incurred 
to purchase books. The final regulations continue to provide that 
qualified expenses include fees for books, supplies, and equipment used 
in a course of study only if the fees must be paid to the institution 
for the enrollment or attendance of the student at the institution. In 
this situation, the amount paid for books is a required fee.
    Other commentators requested clarification as to whether a required 
student health service fee and a required transportation fee are 
qualified expenses. Consistent with the legislative history to section 
25A, the final regulations continue to provide that qualified expenses 
do not include fees for room and board, insurance, medical expenses, 
transportation, and similar personal, living, or family expenses, 
regardless of whether the fee must be paid to the institution as a 
condition of the student's enrollment or attendance. Therefore, a 
required student health fee and a required transportation fee are not 
qualified expenses. The final regulations clarify that, as stated in 
the preamble to the proposed regulations, medical expenses include 
student health fees.
    Several commentators requested clarification of how a required 
general fee (referred to as a bundled fee) should be treated in 
calculating the amount of qualified expenses. These commentators 
explained that often institutions will charge a bundled fee that 
includes charges for both qualified expenses and personal expenses. 
These commentators note that, unlike a comprehensive fee, a bundled fee 
normally does not include tuition charges.
    Section 1.25A-2(d)(4) of the proposed regulations describes the 
treatment of a comprehensive fee, which typically includes charges for 
tuition, fees, and personal expenses. The proposed regulations provide 
that the portion of the comprehensive fee that is allocable to personal 
expenses is not a qualified expense, and require institutions to make a 
reasonable allocation between qualified expenses and personal expenses. 
One commentator recommended that the final regulations provide a 
similar allocation rule for bundled fees. Another commentator 
recommended that institutions should not be required to allocate a 
bundled fee that includes an insubstantial amount of personal expenses. 
Because personal expenses do not qualify for the education tax credit, 
the final regulations clarify that the allocation rule in Sec.  1.25A-
2(d)(4) applies to any required fee that combines charges for both 
qualified expenses and personal expenses (such as comprehensive fees 
and bundled fees).

[[Page 78689]]

    One commentator noted that, under the definition of a hobby course 
in Sec.  1.25A-2(d)(5) of the proposed regulations, one student may be 
enrolled in a course to receive academic credit toward a degree, 
another student may be enrolled in the same course on a noncredit basis 
to acquire or improve job skills, while a third student may be enrolled 
in the same course as a hobby. Under the proposed regulations, the 
first and second students may be eligible to claim an education tax 
credit, but the third student is not. Consistent with sections 
25A(c)(2) and 25A(f)(1)(B), the final regulations continue to provide 
that expenses paid for courses that involve sports, games, or hobbies, 
or any noncredit course, are not qualified expenses, unless the course 
is part of the individual's degree program, or, in the case of the 
Lifetime Learning Credit, the student takes the course to acquire or 
improve job skills.

4. Hope Scholarship Credit

    Several commentators requested clarification of the definition of 
an eligible student for purposes of the Hope Scholarship Credit. One 
commentator recommended that the year of study requirement in the 
regulations should be eliminated and that the credit should be allowed 
for any two years of undergraduate study. The year of study requirement 
derives from the statutory requirements in section 25A. Therefore, the 
final regulations do not adopt this recommendation.
    Another commentator requested clarification as to whether a student 
who completes a one-year postsecondary certificate program and in a 
later year completes another one-year postsecondary certificate program 
(or enrolls in a postsecondary degree program) may claim a Hope 
Scholarship Credit for both years. The final regulations include a new 
example in Sec.  1.25A-3(d)(2) that illustrates that the Hope 
Scholarship Credit is allowable for the first two years of 
postsecondary education, which may include two one-year certificate 
programs.
    Commentators requested clarification of Example 3 in Sec.  1.25A-
3(d)(2). The commentators asked if an otherwise eligible student who 
has not completed the first two years of undergraduate study as of the 
beginning of the taxable year may include qualified expenses paid 
during the entire taxable year in calculating the Hope Scholarship 
Credit, even if the student completes the first two years of 
undergraduate study during the year. The example has been revised to 
clarify that, if a student has not completed the first two years of 
undergraduate study as of the beginning of the taxable year, the 
qualified expenses paid during the entire taxable year may be taken 
into account in calculating the Hope Scholarship Credit. However, in no 
event may a Hope Scholarship Credit be claimed for more than two 
taxable years with respect to the same student.

5. Special Rules Relating to Characterization and Timing of Payments

    Several commentators requested clarification of the rules for 
payments of qualified expenses by a third party. One commentator asked 
how the third party payment rule in Sec.  1.25A-5 of the proposed 
regulations applies in the case of a taxpayer who, although not 
divorced, is not treated as married within the meaning of section 7703. 
The proposed regulations provide that if a third party (someone other 
than the taxpayer, the taxpayer's spouse, or a claimed dependent) pays 
qualified expenses on behalf of a student directly to an institution, 
the student is treated as receiving the payment from the third party 
and, in turn, paying the qualified expenses to the institution. The 
final regulations clarify that, for purposes of Sec.  1.25A-5(b), a 
third party includes the spouse of a taxpayer who is not treated as 
married under section 7703. Thus, for example, if the taxpayer is a 
custodial parent who is not treated as married under section 7703, then 
(assuming that the taxpayer claims the student as a dependent) the 
taxpayer may claim an education tax credit for qualified expenses paid 
by the noncustodial parent on behalf of the student.
    One commentator requested clarification as to whether an education 
tax credit is allowable for the amount of any tuition reduction 
provided by an eligible educational institution to its employees, or 
their spouses or dependent children. The final regulations provide in 
Sec.  1.25A-5(b)(2) that an education tax credit is allowable for the 
amount of any reduction in tuition only if the amount of the tuition 
reduction is included in the employee's gross income.
    Several commentators requested clarification of the rules in Sec.  
1.25A-5(c) of the proposed regulations for reducing the amount of 
qualified expenses paid during the taxable year by the amount of 
certain tax-free educational assistance (including any qualified 
scholarship that is excludable from gross income under section 117) 
received during the taxable year. The proposed regulations provide a 
rule for allocating scholarships between qualified expenses and 
expenses that do not qualify for an education tax credit under section 
25A (nonqualified expenses). The proposed regulations provide that a 
scholarship will be treated as allocated to qualified expenses, and 
thus as a qualified scholarship that reduces qualified expenses, unless 
the student includes the scholarship in income or the terms of the 
scholarship require that it be applied to nonqualified expenses.
    Several commentators asked whether a student may choose to include 
in income a restricted scholarship that, by its terms, must be used to 
pay qualified expenses and claim an education tax credit for qualified 
expenses covered by the scholarship. The test for purposes of section 
25A is whether the scholarship is excludable from gross income under 
section 117, and not whether the student elects to include the 
scholarship in income. The legislative history to section 25A states 
that qualified expenses do not include expenses covered by ``education 
assistance that is not required to be included in the gross income of 
either the student or the taxpayer claiming the credit.'' See H.R. 
Conf. Rep. No. 220, 105th Cong., 1st Sess., at 343 (1997). Section 117 
provides, in general, that gross income shall not include a scholarship 
that, consistent with the terms of the scholarship, is used to pay 
certain qualified expenses. A restricted scholarship that must be used 
to pay qualified expenses is a qualified scholarship excludable under 
section 117. Therefore, for purposes of section 25A, a restricted 
scholarship that must be used to pay qualified expenses reduces the 
amount of qualified expenses that may be taken into account in 
calculating the education tax credit.
    An unrestricted scholarship that may be used to pay any of the 
student's costs of attendance (such as room and board and any other 
incidental expenses) is excludable from gross income only if used to 
pay qualified expenses. To the extent that an unrestricted scholarship, 
or a portion thereof, is used to pay nonqualified expenses and such use 
is consistent with the terms of the scholarship, the scholarship is not 
a qualified scholarship excludable under section 117. In this 
situation, the scholarship is included in gross income and will not 
reduce the amount of qualified expenses that may be taken into account 
in calculating the education tax credit. The final regulations clarify 
that, for purposes of section 25A, a scholarship or fellowship grant is 
treated as a qualified scholarship excludable under section 117 
(thereby reducing the amount of qualified expenses) except to the 
extent: (1) The scholarship may be applied, by its terms, to expenses 
other than

[[Page 78690]]

qualified expenses (such as room and board) and the student reports the 
scholarship as income; or (2) the scholarship must be applied, by its 
terms, to expenses other than qualified expenses (such as room and 
board) and the student reports the scholarship as income.
    One commentator recommended that the final regulations provide that 
loans are not excludable educational assistance within the meaning of 
Sec.  1.25A-5(c), and do not reduce the amount of qualified expenses. 
Section 1.25A-5(e)(3) of the proposed regulations specifically provides 
that amounts paid with loan proceeds may qualify for the education tax 
credit. In addition, an example in Sec.  1.25A-5(c)(4) of the proposed 
regulations provides that a loan is not tax-free educational assistance 
within the meaning of Sec.  1.25A-5(c). The final regulations retain 
these specific provisions on loans.
    The proposed regulations provide that expenses paid with loan 
proceeds disbursed directly to an institution are, in general, treated 
as paid on the date of the disbursement of the proceeds. Several 
commentators recommended that, in accordance with the Department of 
Education regulations in 34 CFR 668.164(a), the date of disbursement 
should be the date the institution credits the student's account with 
the loan proceeds and not the date the lender disburses the loan 
proceeds to the institution. In general, 34 CFR 668.164 regulates the 
disbursement of Federal student loans under title IV of the Higher 
Education Act of 1965 (including the Federal Perkins Loan, Federal 
Family Education Loan, and William D. Ford Direct Loan Program). These 
rules require an institution to verify that a student is enrolled and 
is otherwise eligible to receive the loan proceeds before crediting the 
student's account or releasing the funds to the student. Consistent 
with these Department of Education rules, the final regulations clarify 
that the qualified expenses paid with loan proceeds disbursed directly 
to an institution are treated as paid at the time the loan proceeds are 
actually credited to the student's account. In the case of title IV 
loan programs, Department of Education rules require the institution to 
notify the borrower of the date and the amount of the disbursement at 
the time the institution credits the student's account. See 34 CFR 
668.165(a)(2). However, the final regulations provide that if the 
taxpayer does not know the date the institution credits the student's 
account, the taxpayer must treat the expenses as paid on the last date 
for payment prescribed by the institution.
    Several commentators requested clarification as to when a taxpayer 
may claim an education tax credit for qualified expenses paid through a 
third party installment payment plan. One commentator explained that 
institutions and taxpayers may contract with a third party installment 
payment company to provide an installment payment plan for the 
institution's students. The commentator explained that, in general, the 
company agrees to collect tuition payments over a period of time 
(usually 10 months) and remit the payments to the institution on a 
predetermined schedule. The commentator asked whether a taxpayer is 
treated as paying the qualified expenses when the taxpayer pays the 
third party installment payment company, or when the third party 
disburses the funds to the institution. The final regulations clarify 
that when the expenses are treated as paid for purposes of section 25A 
depends on whether, under the terms of the installment payment 
agreement, the third party is acting as an agent of the taxpayer or as 
an agent of the institution.
    One commentator requested clarification as to whether an education 
tax credit is allowable for any amounts paid for qualified expenses 
that are retained by the institution, under the institution's refund 
policy, when the student withdraws. Section 1.25A-5(f)(1) of the 
proposed regulations provides that the amount of qualified expenses is 
calculated by adding all the qualified expenses paid for the year, and 
subtracting any refund received from the institution during the same 
year. The final regulations retain this rule. Therefore, amounts 
required to be paid for enrollment or attendance are qualified expenses 
to the extent that such amounts are not refunded when the student 
withdraws. The final regulations add a new paragraph Sec.  1.25A-
5(f)(4) to clarify that, with respect to qualified expenses paid with 
the proceeds of a loan, any refund of loan proceeds by the institution 
back to the lender on behalf of the borrower is treated as a refund of 
qualified expenses.
    The proposed regulations provide that if a taxpayer receives a 
refund of qualified expenses paid in a prior taxable year before the 
taxpayer files a Federal income tax return for the prior year, the 
amount of qualified expenses for the prior taxable year is reduced by 
the amount of the refund. One commentator suggested that the taxpayer 
should have the option of claiming the credit for the full amount of 
qualified expenses paid in the prior taxable year and then recapturing 
the credit on the return filed for the taxable year in which the refund 
was received. The rule in the proposed regulations is intended to 
simplify the calculation of the education tax credit by avoiding the 
need to recompute the allowable education tax credit in a later year 
and report any resulting increase in tax. Therefore, the final 
regulations do not adopt the recommendation.
    The final regulations clarify that, in the case of a payment of 
qualified expenses in one taxable year and a refund of qualified 
expenses in a subsequent taxable year, the recapture amount for the 
refund year is the difference in tax liability for the prior taxable 
year (taking into account any redetermination of such tax liability by 
audit or amended return) that results when the tax liability for the 
prior year is calculated using the taxpayer's redetermined credit.

Special Analyses

    It has been determined that this Treasury decision is 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) of the Internal Revenue Code, the proposed regulations 
preceding these regulations were submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Drafting Information

    The principal author of the regulations is Donna Welch, Office of 
Associate Chief Counsel (Procedure & Administration), Administrative 
Provisions & Judicial Practice Division. However, other personnel from 
the IRS and the Treasury Department participated in the development of 
the regulations.

List of Subjects

26 CFR Part 1

    Income tax, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping.

[[Page 78691]]

Adoption of Amendments to the Regulations


    Accordingly, 26 CFR part 1 is 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-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 Sec. Sec.  1.25A-1, 1.25A-
2, 1.25A-3, 1.25A-4, and 1.25A-5.

Sec.  1.25A-1 Calculation of Education Tax Credit and General 
Eligibility Requirements

(a) Amount of education tax 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) Identification requirement.
(f) Claiming the credit in the case of a dependent.
(1) In general.
(2) Examples.
(g) Married taxpayers.
(h) 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 a comprehensive or bundled fee.
(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) Educational expenses paid by claimed dependent.
(b) Educational expenses paid by a third party.
(1) In general.
(2) Special rule for tuition reduction included in gross income of 
employee.
(3) Examples.
(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) 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.
(4) Expenses paid through third party installment payment plans.
(i) In general.
(ii) Example.
(f) Refund of qualified tuition and related expenses.
(1) Payment and refund of qualified tuition and related expenses in 
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.
(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) Refund of loan proceeds treated as refund of qualified tuition 
and related expenses.
(5) Excludable educational assistance received in a subsequent 
taxable year treated as a refund.
(6) Examples.


Sec.  1.25A-1  Calculation of Education Tax Credit and General 
Eligibility Requirements

    (a) Amount of education tax credit. An individual taxpayer is 
allowed a nonrefundable education tax credit against income tax imposed 
by chapter 1 of the Internal Revenue Code for the taxable year. The 
amount of the education tax 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 of the 
Internal Revenue Code, 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 one student may not 
be taken into account in computing the amount of the Hope Scholarship 
Credit with respect to any other student. In addition, 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 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

[[Page 78692]]

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 (see Sec.  1.25A-4(a)) 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 tax 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 tax 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 tax credit is allowed unless a taxpayer 
elects to claim the credit on the taxpayer's 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),'' to the Federal income tax return.
    (e) Identification requirement. No education tax 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).
    (f) 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 tax credit for the student's qualified 
tuition and related expenses. However, if another taxpayer is eligible 
to, but does not, claim the student as a dependent, only the student 
may claim the education tax credit for the student's qualified tuition 
and related expenses.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (f):

    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 tax credit on his Federal income 
tax return, and B is not allowed an education tax 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(a).
    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 tax credit on D's Federal income tax return, 
and Taxpayer C is not allowed an education tax 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(b).

     (g) Married taxpayers. If a taxpayer is married (within the 
meaning of section 7703), no education tax credit is allowed to the 
taxpayer unless the taxpayer and the taxpayer's spouse file a joint 
Federal income tax return for the taxable year.
    (h) 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 tax 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 tax credit with respect to 
the qualified tuition and related expenses of the student unless the 
student is a claimed dependent (as defined in Sec.  1.25A-2(a)).


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. 
Among other requirements under section 152, a nonresident alien student 
must be a resident of a country contiguous to the United States in 
order to be treated as a dependent.
    (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 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; 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 as reasonably determined by an 
eligible educational institution. In the case of an eligible 
educational institution that uses credit hours or clock hours, and does 
not have academic terms, each payment period (as defined in 34 CFR 
668.4, revised as of July 1, 2002) may be treated as an academic 
period.
    (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.

[[Page 78693]]

    (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 fees 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 
(including student health fees), 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 a comprehensive or bundled fee. If a student is 
required to pay a fee (such as a comprehensive fee or a bundled fee) to 
an eligible educational institution that combines charges for qualified 
tuition and related expenses with charges for personal expenses 
described in paragraph (d)(3) of this section, the portion of the fee 
that is allocable to personal expenses is not included in qualified 
tuition and related expenses. The determination of what portion of the 
fee relates to qualified tuition and related expenses and what portion 
relates to personal expenses must be made by the institution using a 
reasonable method of allocation.
    (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, the 
student takes the course to acquire or improve job skills.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (d). In each example, assume that the institution is an 
eligible educational institution and that all other relevant 
requirements to claim an education tax 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, 
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 and other personal expenses. 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 phaseout 
of the education tax 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 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 used 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 tax 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

[[Page 78694]]

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 one-
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 the 
applicable standard 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) (revised as of July 1, 2002) 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 
is enrolled in an undergraduate degree program at College U for the 
1998 Fall semester on a full-time basis. For the 1999 Spring 
semester, Student A again is enrolled at College U on a full-time 
basis. For the 1999 Fall semester, Student A is enrolled 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 is enrolled in at least 
one-half the normal full-time work load for his degree program at 
College V. 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 is enrolled at College V for the 1999 Spring semester on a 
full-time basis. 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. Therefore, the qualified 
expenses and required fees paid for the 1999 Spring semester and the 
1999 Fall semester are taken into account in calculating any Hope 
Scholarship Credit.
    Example 4. Prior to 1998, Student was not enrolled at another 
eligible educational institution. 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 
is enrolled at College W during the 1998 Fall semester and during 
the 1999 Spring and Fall semesters on a full-time basis and is 
classified as a first-semester junior as of the beginning of the 
1999 Spring semester. Because Student C was not enrolled in a 
college or other eligible educational institution prior to 1998 (but 
rather was awarded three semesters of academic credit 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. In addition, 
during the 1999 Spring semester, 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 is enrolled in more than one-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 at least 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. College S is not an eligible educational institution 
for purposes of the education tax credit. At the end of 1998, 
Student E enrolls in an undergraduate degree program at College Z, 
an eligible educational institution, for the 1999 Spring semester on 
a full-time basis. 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 received a degree in 1998 from College R. 
College R is not an eligible educational institution for purposes of 
the education tax credit. During 1999, Student F is enrolled in a 
graduate-degree program at College Y, an eligible educational 
institution, for the 1999 Fall semester on a full-time basis. 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.
    Example 9. Student G graduates from high school in June 2001. In 
January 2002, Student G is enrolled in a one-year postsecondary 
certificate program on a full-time basis to obtain a certificate as 
a travel agent. Student G completes the program in December 2002 and 
is awarded a certificate. In January 2003, Student G enrolls in a 
one-year postsecondary certificate program on a full-time basis to 
obtain a certificate as a computer programer. Student G meets the 
degree requirement, the work load requirement, and the year of study

[[Page 78695]]

requirement for the taxable years 2002 and 2003. Therefore, Student 
G is an eligible student for both taxable years 2002 and 2003.

    (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 is enrolled on a full-time basis 
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 phaseout of the education tax 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 
phaseout of the education tax 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 Taxpayer A 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.

    (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 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) Educational expenses paid by claimed dependent. For any taxable 
year for which the student is a claimed dependent of another taxpayer, 
qualified tuition and related expenses paid by the student are treated 
as paid by the taxpayer to whom the deduction under section 151 is 
allowed.
    (b) Educational expenses paid 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 if the taxpayer is treated as 
married within the meaning of section 7703, 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) Special rule for tuition reduction included in gross income of 
employee. Solely for purposes of section 25A, if an eligible 
educational institution provides a reduction in tuition to an employee 
of the institution (or to the spouse or dependent child of an employee, 
as described in section 132(h)(2)) and the amount of the tuition 
reduction is

[[Page 78696]]

included in the employee's gross income, the employee is treated as 
receiving payment of an amount equal to the tuition reduction and, in 
turn, paying such amount to the institution.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (b). In each example, assume that all the requirements to 
claim an education tax credit are met. The examples are as follows:

    Example 1. 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 tax credit, Student E is treated 
as receiving the money from her grandparent and, in turn, paying her 
qualified tuition and related expenses.
    Example 2. 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 (b)(1) of this section, Student C is 
treated as receiving the money from Parent A and, in turn, paying 
the 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. Under paragraph (a) of this section, expenses 
paid by Student C are treated as paid by Parent B. Thus, Parent B 
may claim an education tax credit for the qualified tuition and 
related expenses paid directly to the institution by Parent A.
    Example 3. University A, an eligible educational institution, 
offers reduced tuition charges to its employees and their dependent 
children. F is an employee of University A. F's dependent child, G, 
enrolls in a graduate-level course at University A. Section 117(d) 
does not apply, because it is limited to tuition reductions provided 
for education below the graduate level. Therefore, the amount of the 
tuition reduction received by G is treated as additional 
compensation from University A to F and is included in F's gross 
income. For purposes of claiming a Lifetime Learning Credit, F is 
treated as receiving payment of an amount equal to the tuition 
reduction from University A and, in turn, paying such amount to 
University A on behalf of F's child, G.

    (c) Adjustment to qualified tuition and related expenses for 
certain excludable educational assistance--(1) In general. In 
determining the amount of an education tax credit, qualified tuition 
and related expenses for any academic period must be reduced by the 
amount of any tax-free educational assistance allocable to such period. 
For this purpose, tax-free educational assistance means--
    (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)(5) of this section.
    (3) Scholarships and fellowship grants. For purposes of paragraph 
(c)(1)(i) of this section, a scholarship or fellowship grant is treated 
as a qualified scholarship excludable under section 117 except to the 
extent--
    (i) The scholarship or fellowship grant (or any portion thereof) 
may 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) and the student reports the grant (or the appropriate 
portion thereof) as income on the student's Federal income tax return 
if the student is required to file a return; or
    (ii) The scholarship or fellowship grant (or any portion thereof) 
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) and the student reports the grant (or the appropriate 
portion thereof) as income on the student's Federal income tax return 
if the student is required to file a return.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (c). In each example, assume that all the requirements to 
claim an education tax 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 Student A a $2,000 scholarship. 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, room and board, and 
other incidental expenses. University X applies the $2,000 
scholarship against Student A's $8,000 total bill, and 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 or attend classes. 
Student A does not report any portion of the scholarship as income 
on her Federal income tax return. Since Student A does not report 
the scholarship as income, the scholarship is treated under 
paragraph (c)(3) of this section as a qualified scholarship that is 
excludable under section 117. Therefore, for purposes of calculating 
an education tax 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 
Student A reports the entire scholarship as income on the student's 
Federal income tax return. Since the full amount of the scholarship 
may be applied to expenses other than qualified expenses (room and 
board) and Student A reports the scholarship as income, the 
exception in paragraph (c)(3) of this section applies and the 
scholarship is not treated as a qualified scholarship excludable 
under section 117. Therefore, for purposes of calculating an 
education tax credit, Student A is treated as having paid $3,000 of 
qualified tuition and related expenses to University X.
    Example 3. The facts are the same as in Example 1, except that 
the terms of the scholarship require it to be used to pay tuition. 
Under paragraph (c)(3) of this section, the scholarship is treated 
as a qualified scholarship excludable under section 117. Therefore, 
for purposes of calculating an education tax 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 4. The facts are the same as in Example 1, except that 
the terms of the scholarship require it to be used to pay tuition or 
room and board charged by University X, and the scholarship amount 
is $6,000. Under the terms of the scholarship, Student A may 
allocate the scholarship between tuition and room and board in any 
manner. However, because room and board totals $5,000, that is the 
maximum amount that can be applied under the terms of the 
scholarship to expenses other than qualified expenses and at least 
$1,000 of the scholarship must be applied to tuition. Therefore, the 
maximum amount of the exception under paragraph (c)(3) of this 
section is $5,000 and at least $1,000 is treated as a qualified 
scholarship excludable under section 117 ($6,000 scholarship-$5,000 
room and board). If Student A reports $5,000 of the scholarship as 
income on the student's Federal income tax return, then Student A 
will be treated as having paid $2,000 ($3,000 tuition-$1,000 
qualified scholarship excludable under section 117) in qualified 
tuition and related expenses to University X.
    Example 5. 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 an education loan and 
pays Student A for working in a work/study job

[[Page 78697]]

in the campus dining hall. The loan is not excludable educational 
assistance within the meaning of paragraph (c) of this section. 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 6. 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 tax credit, Student B is treated as having paid no 
qualified tuition and related expenses to University Y during 1999.

    Example 7. The facts are the same as in Example 6 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 
compensation to Student B. Because the reimbursement is not 
excludable educational assistance within the meaning of paragraph 
(c)(1) of this section, Student B is not required to reduce his 
qualified tuition and related expenses by the $1,000 reimbursement 
he received from his employer. Therefore, for purposes of 
calculating an education tax 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, section 222, 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 tax 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 tax 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 tax 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 classes during the 1999 Spring semester, which begins in 
January 1999. Taxpayer A may claim an education tax credit only in 
1998 for payments made in 1998 for the 1999 Spring semester.

    (3) Expenses paid with loan proceeds. An education tax credit may 
be claimed for 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 the institution credits 
the proceeds to the student's account. For example, in the case of any 
loan issued or guaranteed as part of a Federal student loan program 
under title IV of the Higher Education Act of 1965, loan proceeds will 
be treated as paid on the date of disbursement (as defined in 34 CFR 
668.164(a), revised as of July 1, 2002) by the eligible educational 
institution. If a taxpayer does not know the date the institution 
credits the student's account, the taxpayer must treat the qualified 
tuition and related expenses as paid on the last date for payment 
prescribed by the institution.
    (4) Expenses paid through third party installment payment plans--
(i) In general. A taxpayer, an eligible educational institution, and a 
third party installment payment company may enter into an agreement in 
which the company agrees to collect installment payments of qualified 
tuition and related expenses from the taxpayer and to remit the 
installment payments to the institution. If the third party installment 
payment company is the taxpayer's agent for purposes of paying 
qualified tuition and related expenses to the eligible educational 
institution, the taxpayer is treated as paying the qualified expenses 
on the date the company pays the institution. However, if the third 
party installment payment company is the eligible educational 
institution's agent for purposes of collecting payments of qualified 
tuition and related expenses from the taxpayer, the taxpayer is treated 
as paying the qualified expenses on the date the taxpayer pays the 
company.
    (ii) Example. The following example illustrates the rule of this 
paragraph (e)(4). The example is as follows:

    Example. Student A, Company B, and College C enter into a 
written agreement in which Student A agrees to pay the tuition 
required to attend College C in 10 equal monthly installments to 
Company B. Under the written agreement, Student A is not relieved of 
her obligation to pay College C until Company B remits the payments 
to College C. Under the written agreement, Company B agrees to 
disburse the monthly installment payments to College C within 30 
days of receipt. Because Company B acts as Student A's agent for 
purposes of paying qualified expenses to College C, Student A is 
treated as paying qualified expenses on the date Company B disburses 
payments to College C.

    (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 (including refunds 
of loan proceeds described in paragraph (f)(4) of this section).
    (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 someone 
other than the taxpayer receives a refund (including refunds of loan 
proceeds described in paragraph (f)(4) of this section) of qualified 
tuition and related expenses paid on behalf of a student 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 someone other than the 
taxpayer receives a refund (including refunds of loan proceeds 
described in paragraph (f)(4) of

[[Page 78698]]

this section) of qualified tuition and related expenses paid on behalf 
of a student for which the taxpayer claimed an education tax 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 in 
tax liability for the prior taxable year (taking into account any 
redetermination of such tax liability by audit or amended return) that 
results when the tax liability for the prior year is calculated using 
the taxpayer's redetermined credit. The redetermined credit is computed 
by reducing the amount of the qualified tuition and related expenses 
taken into account in determining any credit 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 
allowable 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).
    (4) Refund of loan proceeds treated as refund of qualified tuition 
and related expenses. If loan proceeds used to pay qualified tuition 
and related expenses (as described in paragraph (e)(3) of this section) 
during a taxable year are refunded by an eligible educational 
institution to a lender on behalf of the borrower, the refund is 
treated as a refund of qualified tuition and related expenses for 
purposes of paragraphs (f)(1), (2), and (3) of this section.
    (5) Excludable educational assistance received in a subsequent 
taxable year treated as a refund. If, in a taxable year, a taxpayer or 
someone other than the taxpayer receives any excludable educational 
assistance (described in paragraph (c)(1) of this section) for the 
qualified tuition and related expenses paid on behalf of a student 
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 the excludable educational assistance 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 excludable 
educational assistance as provided in paragraph (f)(2) of this section. 
If the excludable educational assistance is received after the taxpayer 
has filed a Federal income tax return for the prior taxable year, any 
education tax credit claimed for the prior taxable year is subject to 
recapture as provided in paragraph (f)(3) of this section.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (f). In each example, assume that all the requirements to 
claim an education tax 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 a $750 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 $250 
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 ($750 + $250 = $1,000); 
and, then
    (iii) Subtracting paragraph (ii) of this Example 1 from 
paragraph (i) of this Example 1 ($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, which reduces her tax liability for 1998 by $400. On February 
15, 1999, Student B receives a $500 refund from College Y.
    (ii) Student B calculates the increase in tax for 1999 by--
    (A) Calculating the redetermined qualified expenses for 1998 
($2,000 - $500 = $1,500);
    (B) Calculating the redetermined credit for the redetermined 
qualified expenses ($1,500 x .20 = $300); and
    (C) Calculating the difference in tax liability for 1998 
resulting from the redetermined credit. Because Student B's tax 
liability for 1998 was reduced by the full amount of the $400 
education tax credit claimed on her 1998 income tax return, the 
difference in tax liability can be determined by 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), 
which reduces Student C's tax liability for 1998 by $240. 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 tax credit claimed by Student C for 1998 is 
subject to recapture. Because Student C paid no net qualified 
tuition and related expenses for 1998, the redetermined credit for 
1998 is zero. Student C must increase the amount of Student C's 1999 
tax by the recapture amount, which is $240 (the difference in tax 
liability for 1998 resulting from the redetermined credit for 1998 
($0)). Because the $1,200 reimbursement relates to expenses for 
which the taxpayer claimed an education tax credit in a prior year, 
the reimbursement does not reduce the amount of any qualified 
tuition and related expenses that Student C paid in 1999.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


    Par. 4. In section 602.101, paragraph (b) is revised by adding the 
following entry in numerical order to the table:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

 
                                                          Current OMB
 CFR part or section where  identified and described      control No.
 
 
                                * * * * *
1.25A-1..............................................          1545-1630
 
                                * * * * *
 


Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 13, 2002.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 02-32453 Filed 12-24-02; 8:45 am]
BILLING CODE 4830-01-P