Education Tax Credits

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-106388-98] RIN 1545-AW65
Education Tax Credits
AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and requests to hold a
videoconference public hearing.

SUMMARY: This document contains proposed regulations relating to
the Hope Scholarship Credit and the Lifetime Learning Credit in
section 25A of the Internal Revenue Code. These proposed
regulations provide guidance to individuals who may claim the
Hope Scholarship Credit or the Lifetime Learning Credit for
certain postsecondary educational expenses. This document also
announces that a public hearing will be held on the proposed
regulations upon request and that persons outside the Washington,
DC, area who wish to testify at the hearing may request that the
IRS videoconference the hearing to their sites.

DATES: Written or electronically generated comments must be
received by April 6, 1999. Requests to videoconference the
hearing to other sites must be received by March 8, 1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R
(REG-106388-98), room 5226, Internal Revenue Service, 
POB 7604, Ben Franklin Station, Washington, DC 20044.

Submissions may be hand delivered Monday through Friday between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-106388-
98), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue., NW., Washington, DC. Alternatively, taxpayers may
submit comments electronically via the internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS internet site at
http://www.irs.ustreas.gov/prod/tax_regs/comments.html. The IRS
will publish the time and date of the public hearing and the
locations of any videoconferencing sites in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,
Donna Welch, (202) 622-4910; concerning submissions of comments,
the hearing, and/or to be placed on the building access list to
attend the hearing, contact Michael L. Slaughter, (202) 622-7190
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of
proposed rulemaking has been submitted to the Office of
Management and Budget for review in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the
collection of information should be sent to the Office of
Management and Budget, Attn: Desk Officer for the Department of
the Treasury, Office of Information and Regulatory Affairs,
Washington, DC 20503, with copies to the Internal Revenue.3
Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224. Comments on the collection of information
should be received by March 8, 1999. Comments are specifically
requested concerning:

Whether the proposed collection of information is necessary
for the proper performance of the functions of the Internal
Revenue Service, including whether the information will have
practical utility;
The accuracy of the estimated burden associated with the
proposed collection of information (see below);
How the quality, utility, and clarity of the information to
be collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the
application of automated collection techniques or other
forms of information technology; and
Estimates of capital or start-up costs and costs of
operation, maintenance, and purchase of services to provide
information.

The collection of information in this proposed regulation is
in �1.25A-1(d) and (f). Taxpayers must elect to claim an
education credit by attaching Form 8863, "Education Credits (Hope
and Lifetime Learning Credits)," to a timely filed (including
extensions) federal income tax return for the taxable year in
which a credit is claimed. This collection of information is
required in order for a taxpayer to elect to claim an education 
credit. This information will be used to carry out the internal
revenue laws. The likely respondents are individuals.

The reporting burden contained in �1.25A-1(d) and (f) is
reflected in the burden of Form 8863, "Education Credits (Hope
and Lifetime Learning Credits)," and Form 1040, "U.S. Individual
Income Tax Return."
An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless
it displays a valid control number assigned by the Office
of Management and Budget.

Books or records relating to a collection of information
must be retained as long as their contents may become
material in the administration of any internal revenue
law. Generally, tax returns and tax return information are
confidential, as required by 26 U.S.C. 6103.

Background

The Taxpayer Relief Act of 1997 (Public Law 105-34 (111
Stat. 788) (TRA '97)) added section 25A to the Internal Revenue
Code to provide the Hope Scholarship Credit and the Lifetime
Learning Credit (education credits). In general, the Hope
Scholarship Credit and the Lifetime Learning Credit allow
taxpayers to claim a nonrefundable credit against their federal
income taxes for certain postsecondary educational expenses. On
November 17, 1997, the IRS published Notice 97-60 (1997-46 I.R.B.

8) to provide general guidance on the higher education tax
incentives enacted by TRA '97, including the Hope Scholarship 
Credit and the Lifetime Learning Credit. This document contains
proposed amendments to the Income Tax Regulations (26 CFR part 1)
to provide detailed guidance on the education credits in section
25A.

TRA '97 also added section 6050S to the Code, which requires
eligible educational institutions to file information returns to
assist taxpayer and the IRS in determining the education credit
that taxpayers may claim under section 25A. The IRS has
published several notices outlining the limited information
returns that are required for 1998 and 1999. On December 22,
1997, the IRS published Notice 97-73 (1997-51 I.R.B. 16), which
describes the information that must be reported for 1998. On
September 8, 1998, the IRS published Notice 98-46 (1998-36 I.R.B.

21), which extends the application of Notice 97-73 to information
returns required under section 6050S for 1999. Finally, on
December 7, 1998, the IRS published Notice 98-59 (1998-49 I.R.B.

16), which modified the two prior Notices by providing that an
eligible educational institution is not required to file
information returns under section 6050S for 1998 or 1999 with
respect to either: (1) students who are enrolled during the year
only in courses for which the student receives no academic credit
from the educational institution; or (2) nonresident alien
students, unless requested to do so by the student. The IRS and
the Treasury Department intend to issue separate regulations on
the information reporting required under section 6050S for years
after 1999..6
Explanation of Provisions
1. Calculation of Education Credit and General Eligibility
Requirements
Under the proposed regulations, a taxpayer may claim a
nonrefundable education credit equal to the total of the Hope
Scholarship Credit and the Lifetime Learning Credit allowed for
the taxpayer, the taxpayer's spouse, and any claimed dependents.

An education credit in excess of a taxpayer's tax liability for
the taxable year can not be refunded. As with other personal
credits, section 25A does not allow a carryforward of an unused
education credit or a carryforward of excess qualified expenses.

The proposed regulations provide rules for the coordination
of the Hope Scholarship Credit and the Lifetime Learning Credit.

The proposed regulations provide that, in the same taxable year,
a taxpayer may claim a Hope Scholarship Credit for each eligible
student's qualified tuition and related expenses and a Lifetime
Learning Credit for one or more other students' qualified tuition
and related expenses. The regulations provide that a taxpayer
may claim either the Hope Scholarship Credit or the Lifetime
Learning Credit, but not both, for the qualified tuition and
related expenses of the same student in the same taxable year. A
Hope Scholarship Credit may be claimed for the qualified tuition
and related expenses (up to a specified limit described below) of
each eligible student. The Lifetime Learning Credit may be
claimed for the aggregate amount of qualified tuition and related
expenses (up to a specified limit described below) of those
students for whom no Hope Scholarship Credit is claimed.

Consistent with the income limitations in section 25A(d),
the proposed regulations provide that the education credit
allowed is phased out for taxpayers with modified adjusted gross
income between $40,000 and $50,000 ($80,000 and $100,000 for
taxpayers filing a joint return) for the taxable year. For
taxable years beginning after 2001, these amounts will be
adjusted for inflation. Based on the definition in section
25A(d)(3), the regulations define modified adjusted gross income
as the adjusted gross income (as defined in section 62) of the
taxpayer for the taxable year increased by any amount excluded
from gross income under section 911, 931, or 933 (relating to
income earned abroad or from certain U.S. possessions or Puerto
Rico). The amount of an otherwise allowable education credit for
a taxable year that is reduced solely by reason of the modified
adjusted gross income limitation can not be carried forward and
claimed in a subsequent taxable year.

Consistent with the requirements in section 25A(e)(1), the
proposed regulations provide that a taxpayer must elect to claim
the education credit. The election must be made by attaching
Form 8863, "Education Credits (Hope and Lifetime Learning
Credits)," to the taxpayer's federal income tax return for the
taxable year in which the credit is claimed. Consistent with the
identification requirements in section 25A(g)(1), the regulations
provide that a taxpayer must include on the federal income tax
return the name and taxpayer identification number of each
student for whom the credit is claimed.

Consistent with the requirements in section 25A(e)(2), the
proposed regulations provide that no education credit is allowed
for a taxable year for the qualified tuition and related expenses
of a student if: (1) during the taxable year, a distribution is
made to, or on behalf of, the student from an education
individual retirement account described in section 530(b); and
(2) any portion of the distribution is excluded from gross income
under section 530(d)(2).

The proposed regulations provide guidance on the rules for
claiming an education credit in the case of a dependent. The
regulations provide that, if the student is a claimed dependent
of another taxpayer, only that taxpayer may claim the education
credit for the student's qualified tuition and related expenses.

The regulations explain that, if the taxpayer is eligible to, but
does not, claim the student as a dependent, only the student may
claim the education credit for the student's qualified tuition
and related expenses.

2. Definitions
The proposed regulations provide that a claimed dependent is
a dependent (as defined in section 152) for whom a deduction
under section 151 is allowed on the taxpayer's federal income tax
return for the taxable year in which the credit is claimed.

Based on the requirements of section 25A(f)(2), the proposed
regulations provide that an eligible educational institution
means a college, university, vocational school, or other
postsecondary educational institution that: (1) is described in 
section 481 of the Higher Education Act of 1965 (HEA) (20 U.S.C.

1088) as in effect on August 5, 1997 (generally all accredited
public, nonprofit, and proprietary postsecondary institutions);
and (2) participates in a federal student financial aid program
under title IV of the HEA (20 U.S.C. 1070 et seq.) or is
certified by the Department of Education as eligible to
participate in such a program but chooses not to participate.

The proposed regulations provide that academic period means
a quarter, semester, trimester, or other period of study (such as
a summer school session) as reasonably determined by the eligible
educational institution. Neither section 25A nor its legislative
history defines the term academic period. Additionally, the
Department of Education does not have a recognized definition of
academic period. The definition in the regulation is intended to
include institutions that use traditional academic terms and
institutions that do not use academic terms, but for example use
clock hours or credit hours. The IRS and Treasury invite
comments on this definition of academic period as well as
suggestions on alternative definitions.

Based on the definition in section 25A(f)(1), the proposed
regulations define qualified tuition and related expenses as the
tuition and fees required for the enrollment or attendance of a
student for courses of instruction at an eligible educational
institution. This definition is generally consistent with the
definition of tuition and fees contained in section 472(1) of the
HEA (20 U.S.C. 1087ll(1)). See H.R. Conf. Rep. No. 599, 105th.10
Cong., 2d Sess., at p. 321 (1998). The regulations provide that,
in general, the test for determining whether a fee is treated as
a qualified tuition and related expense is whether the fee is
required to be paid to the eligible educational institution by
students as a condition of the students' enrollment or attendance
at the institution. The regulations specifically provide that
qualified tuition and related expenses include fees for books,
supplies, and equipment used in a course of study only if the
fees must be paid to the eligible educational institution for the
enrollment or attendance of the student at the institution.

Similarly, the regulations provide that, in general, qualified
tuition and related expenses include nonacademic fees (fees
charged by an eligible educational institution that are not used
directly for, or allocated to, an academic course of study) only
if the fees must be paid to the eligible educational institution
for the enrollment or attendance of the student at the
institution.

However, based on the legislative history to section 25A,
the proposed regulations provide that qualified tuition and
related expenses do not include the costs of room and board,
insurance, medical expenses (such as student health fees),
transportation, and similar personal, living, or family expenses,
regardless of whether the fees must be paid to the eligible
educational institution for the enrollment or attendance of the
student at the institution. See H.R. Conf. Rep. No. 220, 105th
Cong., 1st Sess., at p. 343, 346 (1997). Further, based on the 
limitations in section 25A(f)(1)(B) and (c)(2)(B), the
regulations provide that qualified tuition and related expenses
do not include expenses that relate to any course of instruction
or other education that involves sports, games, hobbies, or any
noncredit course, unless the course is part of the student's
degree program or, in the case of the Lifetime Learning Credit,
is taken by the student to acquire or improve job skills.

3. Hope Scholarship Credit
The Hope Scholarship Credit is a per student credit that may
be claimed for each eligible student. Consistent with the
provisions of section 25A(b)(1), the proposed regulations provide
that for taxable years beginning before 2002 the maximum Hope
Scholarship Credit amount is $1,500 (100 percent of the first
$1,000 of the qualified tuition and related expenses paid during
the taxable year for education furnished to an eligible student
during any academic period beginning in the taxable year or
treated as beginning in the taxable year, plus 50 percent of the
next $1,000 of such expenses paid with respect to that student).

For taxable years beginning after 2001, the $1,000 amounts will
be adjusted for inflation. Consistent with the provisions of
section 25A(b)(2)(A), the regulations provide that the Hope
Scholarship Credit is allowed for only two taxable years for each
eligible student.

Based on the requirements in section 25A(b)(2) and (3), the
proposed regulations define an eligible student for purposes of
the Hope Scholarship Credit as a student who meets all of the 
following requirements: (1) for at least one academic period
during the taxable year, the student enrolls at an eligible
educational institution in a program leading toward a
postsecondary degree, certificate, or other recognized
postsecondary educational credential (degree requirement);
(2) for at least one academic period during the taxable year, the
student enrolls for at least half of the normal full-time work
load for the course of study the student is pursuing (work load
requirement); (3) as of the beginning of the taxable year, the
student has not completed the first two years of postsecondary
education at an eligible educational institution (year of study
requirement); and (4) the student has not been convicted of a
federal or state felony offense for the possession or
distribution of a controlled substance as of the end of the
taxable for which the credit is claimed (felony drug conviction
restriction).

The proposed regulations explain that the student meets the
work load requirement if the student is enrolled for at least
half of the normal full-time work load, as determined by the
eligible educational institution. The regulations provide that
the educational institution's standards for a half-time work load
must equal or exceed the standards established by the Department
of Education under the HEA and set forth in 34 CFR 674.2(b) for a
half-time undergraduate student.

The proposed regulations explain that whether a student has
completed the first two years of postsecondary education as of 
the beginning of the taxable year is based on whether the
eligible educational institution the student is enrolled in
awards the student two years of academic credit for postsecondary
course work completed by the student prior to the beginning of
the taxable year. However, the regulations provide that any
academic credit awarded by the educational institution solely on
the basis of the student's performance on proficiency
examinations is not taken into account.

The proposed regulations provide that the Hope Scholarship
Credit is effective for expenses paid after December 31, 1997,
for education furnished in academic periods beginning after that
date.

4. Lifetime Learning Credit
The Lifetime Learning Credit is a per taxpayer credit,
rather than a per student credit. For taxable years beginning
before 2003, the maximum Lifetime Learning Credit amount is
$1,000 (20 percent of up to $5,000 of the aggregate qualified
tuition and related expenses paid during the taxable year for
education furnished to the taxpayer, the taxpayer's spouse, and
any claimed dependent during any academic period beginning in the
taxable year or treated as beginning in the taxable year). For
taxable years beginning on or after 2003, the maximum credit
amount is $2,000 (20 percent of up to $10,000 of the aggregate
qualified tuition and related expenses paid during the taxable
year for education furnished to the taxpayer, the taxpayer's
spouse, and any claimed dependent during any academic period 
beginning in the taxable year or treated as beginning in the
taxable year).

In contrast to the Hope Scholarship Credit, the Lifetime
Learning Credit is allowed for an unlimited number of years for
each student and does not have a degree requirement, year of
study requirement, work load requirement, or a felony drug
conviction restriction. See H.R. Conf. Rep. No. 220, 105th
Cong., 1st Sess., at p. 346-347 (1997). Therefore, a taxpayer
may claim a Lifetime Learning Credit for a student's qualified
tuition and related expenses even if the taxpayer could not claim
a Hope Scholarship Credit for those expenses.

Based on the provisions of section 25A(c)(2)(B) and the
legislative history to section 25A, the proposed regulations
provide that, for purposes of claiming a Lifetime Learning
Credit, amounts that a taxpayer is required to pay for a course
at an eligible educational institution are qualified tuition and
related expenses if the course is either part of a postsecondary
degree program or is part of a nondegree program that is taken by
the student to acquire or improve job skills. The legislative
history explains that the Lifetime Learning Credit is available
with respect to any course of instruction at any eligible
educational institution (whether the student is enrolled on a
full-time, half-time, or less than half-time basis) to acquire or
improve job skills of the student. See H.R. Conf. Rep. No. 220,
105th Cong., 1st Sess., at p. 346-347 (1997).

The proposed regulations provide that the Lifetime Learning 
Credit is effective for expenses paid after June 30, 1998, for
education furnished in academic periods beginning after that
date.

5. Special Rules Relating to Characterization and Timing of
Payments
The proposed regulations provide guidance on qualified
tuition and related expenses paid by a third party. The
regulations provide that, solely for purposes of section 25A, if
a third party makes a payment directly to an eligible educational
institution to pay for a student's qualified tuition and related
expenses, the student is treated as receiving the payment from
the third party, and, in turn, paying the qualified tuition and
related expenses to the institution.

Consistent with the provisions of section 25A(g)(3), the
proposed regulations provide that qualified tuition and related
expenses paid by a student are treated as paid by the taxpayer if
the student is a claimed dependent of the taxpayer.

The proposed regulations provide rules for adjustments to
qualified tuition and related expenses for certain excludable
educational assistance. Consistent with the provisions of
section 25A(g)(2) and the legislative history, the regulations
provide that the amount of otherwise allowable qualified tuition
and related expenses paid during a taxable year must be reduced
by the following amounts paid to, or on behalf of, a student
during the taxable year: (1) a qualified scholarship that is
excludable from gross income under section 117; (2) a veterans'
or member of the armed forces' educational assistance allowance 
under chapter 30, 31, 32, 34, or 35 of title 38, U.S.C., or
chapter 1606 of title 10, U.S.C.; (3) employer-provided
educational assistance that is excludable from gross income under
section 127; and (4) any other educational assistance that is
excludable from gross income (other than as a gift, bequest,
devise, or inheritance within the meaning of section 102(a)).

See H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess., at p. 343,
347 (1997).

The proposed regulations provide rules for allocating
scholarships and fellowship grants among expenses. The
regulations provide that a scholarship or fellowship grant is
treated as a qualified scholarship excludable from income under
section 117 (and thereby reduces the amount of qualified tuition
and related expenses that a taxpayer may otherwise include in
claiming an education credit) unless either: (1) the student
reports the grant as income on the student's federal income tax
return; or (2) the grant must be applied, by its terms, to
expenses other than qualified tuition and related expenses within
the meaning of section 117(b)(2), such as room and board.

The proposed regulations provide guidance on the timing
rules for claiming an education credit. Consistent with the
general rule in section 25A(b)(1) and (c)(1), the regulations
provide that an education credit generally is allowed only for
payments of qualified tuition and related expenses that cover an
academic period beginning in the same taxable year as the year
the payment is made. However, consistent with the specific.17
prepayment rule in section 25A(g)(4), the regulations provide
that, if qualified tuition and related expenses are paid during a
taxable year to cover an academic period that begins during the
first three months of the taxpayer's next taxable year, an
education credit is allowed only in the taxable year in which the
expenses are paid. Note, however, that because the Hope
Scholarship Credit does not apply to expenses paid before
January 1, 1998, and the Lifetime Learning Credit does not apply
to expenses paid before July 1, 1998, the prepayment rule does
not apply for tuition paid in 1997 to cover an academic period
beginning in 1998.

Consistent with the legislative history to section 25A, the
proposed regulations provide that an education credit may be
claimed for the qualified tuition and related expenses paid with
the proceeds of a loan only in the taxable year in which the
expenses are paid, and not in the taxable year in which the loan
is repaid. See H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess.,
at p. 342, 346 (1997). In order to provide taxpayers with a date
certain for payment, the regulations provide that loan proceeds
disbursed directly to an educational institution are treated as
paid on the date of the disbursement. However, if the taxpayer
does not know the date of the disbursement, the taxpayer must
treat qualified tuition and related expenses as paid on the last
date prescribed for payment by the educational institution.

Consistent with the directive in section 25A(i), the
proposed regulations provide rules for refunds of qualified.18
tuition and related expenses. The regulations provide that, if a
payment and a refund of qualified tuition and related expenses
occur in the same taxable year, the amount of qualified tuition
and related expenses for the taxable year is calculated by adding
all qualified tuition and related expenses paid for the taxable
year, and subtracting any refund of the expenses received from
the eligible educational institution during the same taxable
year.

The proposed regulations provide that, if, in a taxable
year, a taxpayer (or the taxpayer's spouse or a claimed
dependent) receives a refund from an eligible educational
institution of qualified tuition and related expenses paid in a
prior taxable year and the refund is received before the taxpayer
files a federal income tax return for the prior taxable year, the
amount of the qualified tuition and related expenses for the
prior taxable year must be reduced by the amount of the refund.

Similar to the tax benefit rule, the proposed regulations
provide that, if, in a taxable year, a taxpayer (or the
taxpayer's spouse or a claimed dependent) receives a refund of
qualified tuition and related expenses for which the taxpayer
claimed an education credit in a prior taxable year, the tax for
the subsequent taxable year is increased by the recapture amount.

The recapture amount is the difference between the credit claimed
in the prior taxable year and the redetermined credit. The
redetermined credit is computed by reducing the amount of the
qualified tuition and related expenses for which a credit was.19
claimed in the prior taxable year by the amount of the refund of
the qualified tuition and related expenses (redetermined
qualified expenses), and computing the credit using the
redetermined qualified expenses and the relevant facts and
circumstance of the prior taxable year, such as modified adjusted
gross income.

The proposed regulations provide that, if, in a taxable
year, any excludable educational assistance is received for the
qualified tuition and related expenses paid during a prior
taxable year, the educational assistance is treated as a refund
of qualified tuition and related expenses. In this situation, if
a taxpayer (or the taxpayer's spouse or a claimed dependent)
receives any excludable educational assistance before the
taxpayer files a federal income tax return for the prior taxable
year, the amount of the qualified tuition and related expenses
for the prior taxable year is reduced by the amount of the
excludable educational assistance. However, if a taxpayer (or
the taxpayer's spouse or claimed dependent) receives excludable
educational assistance after the taxpayer has filed a federal
income tax return for the prior taxable year, any education
credit claimed for the prior taxable year is subject to
recapture.

6. Proposed Effective Date
These regulations are proposed to be effective on the date
they are published in the Federal Register as final regulations.

Taxpayers may rely on these proposed regulations for guidance.20
pending the issuance of final regulations. If, and to the
extent, future guidance is more restrictive than the guidance in
the proposed regulations, the future guidance will be applied
without retroactive effect.

Special Analyses
It has been determined that these proposed regulations are
not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these
regulations, and because the regulations do not impose a
collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f), this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.

Comments and Public Hearing
Before these proposed regulations are adopted as final
regulations, consideration will be given to any written and
electronic comments that are submitted timely to the IRS. The
IRS and Treasury specifically request comments on the clarity of
the proposed regulations and how they can be made easier to
understand. All comments will be available for public inspection
and copying.

A public hearing will be scheduled in the Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC. The IRS.21
recognizes that persons outside the Washington, DC, area may also
wish to testify at the public hearing through videoconferencing.

Requests to include videoconferencing sites must be received by
March 8, 1999. If the IRS receives sufficient indications of
interest to warrant videoconferencing to a particular city, and
if the IRS has videoconferencing facilities available in that
city on the date the public hearing is to be scheduled, the IRS
will try to accommodate the requests.

The IRS will publish the time and date of the public hearing
and the locations of any videoconferencing sites in an
announcement in the Federal Register.

Drafting Information
The principal author of the regulations is Donna Welch,
Office of Assistant Chief Counsel (Income Tax and Accounting).

However, other personnel from the IRS and the Treasury Department
participated in the development of the regulations.

List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as
follows:

PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended
by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *
Section 1.25A-0 also issued under section 26 U.S.C. 25A(i)..22
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:

�1.25A-0 Table of contents.

This section lists captions contained in ��1.25A-1, 1.25A-2,
1.25A-3, 1.25A-4, and 1.25A-5.

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

(a) Amount of education credit.

(b) Coordination of Hope Scholarship Credit and Lifetime Learning
Credit.

(1) In general.

(2) Hope Scholarship Credit.

(3) Lifetime Learning Credit.

(4) Examples.

(c) Limitation based on modified adjusted gross income.

(1) In general.

(2) Modified adjusted gross income defined.

(3) Inflation adjustment.

(d) Election.

(e) Coordination with Education IRA.

(f) Identification requirement.

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

(1) In general.

(2) Examples.

(h) Married taxpayers.

(i) Nonresident alien taxpayers and dependents.

�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..23
(2) Required fees.

(i) In general.

(ii) Books, supplies, and equipment.

(iii) Nonacademic fees.

(3) Personal expenses.

(4) Treatment of comprehensive fees.

(5) Hobby courses.

(6) Examples.

�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.

�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.

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

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

(1) In general.

(2) Example.

(b) Expenses paid by dependent.

(1) In general..24
(2) Example.

(c) Adjustment to qualified tuition and related expenses for
certain excludable educational assistance.

(1) In general.

(2) No adjustment for excludable educational assistance
attributable to expenses paid in a prior year.

(3) Allocation of scholarships and fellowship grants.

(4) Examples.

(d) No double benefit.

(e) Timing rules.

(1) In general.

(2) Prepayment rule.

(i) In general.

(ii) Example.

(3) Expenses paid with loan proceeds.

(f) Refund of qualified tuition and related expenses.

(1) Payment and refund of qualified tuition and related expenses
in the same taxable year.

(2) Payment of qualified tuition and related expenses in one
taxable year and refund in subsequent taxable year before return
filed for prior taxable year.

(3) Payment of qualified tuition and related expenses in one
taxable year and refund in subsequent taxable year.

(i) In general.

(ii) Recapture amount.

(4) Excludable educational assistance received in a subsequent
taxable year treated as refund.

(5) Examples.

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

(a) Amount of education credit. An individual taxpayer is
allowed a nonrefundable education credit against income tax
imposed by chapter 1 of the Internal Revenue Code for the taxable
year. The amount of the education credit is the total of the
Hope Scholarship Credit (as described in �1.25A-3) plus the
Lifetime Learning Credit (as described in �1.25A-4). For
limitations on the credits allowed by subpart A of part IV of
subchapter A of chapter 1, see section 26.

(b) Coordination of Hope Scholarship Credit and Lifetime
Learning Credit--(1) In general. In the same taxable year, a.25
taxpayer may claim a Hope Scholarship Credit for each eligible
student's qualified tuition and related expenses (as defined in
�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 �1.25A-3(
d)). Qualified tuition and related expenses paid during a
taxable year with respect to any student for whom a Hope
Scholarship Credit is claimed may not be taken into account in
computing the amount of the Hope Scholarship Credit with respect
to any other student or the Lifetime Learning Credit.

(3) Lifetime Learning Credit. Subject to certain
limitations, a Lifetime Learning Credit may be claimed for the
aggregate amount of qualified tuition and related expenses paid
during a taxable year with respect to students for whom no Hope
Scholarship Credit is claimed.

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

Example 1. In 1999, Taxpayer A pays qualified tuition and
related expenses for his dependent, B, to attend College Y during
1999. Assuming all other relevant requirements are met, Taxpayer
A may claim either a Hope Scholarship Credit or a Lifetime
Learning Credit with respect to dependent B, but not both. See
�1.25A-3(a) and �1.25A-4(a)..26
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 �1.25A-3(a))
and a Lifetime Learning Credit for the $500 of qualified tuition
and related expenses incurred to improve her job skills.

Example 3. The facts are the same as in Example 2, except
that Taxpayer C pays $3,000 in qualified tuition and related
expenses for her dependent, D, to attend College Z during 1999.

Although a Hope Scholarship Credit is available only with respect
to the first $2,000 of qualified tuition and related expenses
paid with respect to D (see �1.25A-3(a)), Taxpayer C may not add
the $1,000 of excess expenses to her $500 of qualified tuition
and related expenses in computing the amount of the Lifetime
Learning Credit.

(c) Limitation based on modified adjusted gross income--(1)
In general. The education credit that a taxpayer may otherwise
claim is phased out ratably for taxpayers with modified adjusted
gross income between $40,000 and $50,000 ($80,000 and $100,000
for married individuals who file a joint return). Thus,
taxpayers with modified adjusted gross income above $50,000 (or
$100,000 for joint filers) may not claim an education credit.

(2) Modified adjusted gross income defined. The term
modified adjusted gross income means the adjusted gross income
(as defined in section 62) of the taxpayer for the taxable year
increased by any amount excluded from gross income under section
911, 931, or 933 (relating to income earned abroad or from
certain U.S. possessions or Puerto Rico).

(3) Inflation adjustment. For taxable years beginning after
2001, the amounts in paragraph (c)(1) of this section will be
increased for inflation occurring after 2000 in accordance with.27
section 1(f)(3). If any amount adjusted under this paragraph
(c)(3) is not a multiple of $1,000, the amount will be rounded to
the next lowest multiple of $1,000.

(d) Election. No education credit is allowed unless a
taxpayer elects to claim the credit on the taxpayer's timely
filed (including extensions) federal income tax return for the
taxable year in which the credit is claimed. The election is
made by attaching Form 8863, "Education Credits (Hope and
Lifetime Learning Credits)," (or its successor) to that federal
income tax return.

(e) Coordination with Education IRA. No education credit is
allowed for a taxable year for the qualified tuition and related
expenses of a student if--
(1) During the taxable year, a distribution is made to, or
on behalf of, the student from an education individual retirement
account described in section 530(b) (Education IRA); and
(2) Any portion of the distribution is excluded from gross
income under section 530(d)(2).

(f) Identification requirement. No education credit is
allowed unless a taxpayer includes on the federal income tax
return claiming the credit the name and the taxpayer
identification number of the student for whom the credit is
claimed. For rules relating to assessment for an omission of a
correct taxpayer identification number, see section 6213(b) and
(g)(2)(J).

(g) Claiming the credit in the case of a dependent--(1) In.28
general. If a student is a claimed dependent of another
taxpayer, only that taxpayer may claim the education credit for
the student's qualified tuition and related expenses. However,
if the taxpayer is eligible to, but does not, claim the student
as a dependent, only the student may claim the education credit
for the student's qualified tuition and related expenses.

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

Example 1. In 1999, Taxpayer A pays qualified tuition and
related expenses for his dependent, B, to attend University Y
during 1999. Taxpayer A claims B as a dependent on his federal
income tax return. Therefore, assuming all other relevant
requirements are met, Taxpayer A is allowed an education credit
on his federal income tax return, and B is not allowed an
education credit on B's federal income tax return. The result
would be the same if B paid the qualified tuition and related
expenses. See �1.25A-5(b).

Example 2. In 1999, Taxpayer C has one dependent, D. In
1999, D pays qualified tuition and related expenses to attend
University Z during 1999. Although Taxpayer C is eligible to
claim D as a dependent on her federal income tax return, she does
not do so. Therefore, assuming all other relevant requirements
are met, D is allowed an education credit on D's federal income
tax return, and Taxpayer C is not allowed an education credit on
her federal income tax return, with respect to D's education
expenses. The result would be the same if C paid the qualified
tuition and related expenses on behalf of D. See �1.25A-5(a).

(h) Married taxpayers. If a taxpayer is married (within the
meaning of section 7703), no education credit is allowed unless
the taxpayer and the taxpayer's spouse file a joint federal
income tax return for the taxable year.

(i) Nonresident alien taxpayers and dependents. If a
taxpayer or the taxpayer's spouse is a nonresident alien for any
portion of the taxable year, no education credit is allowed
unless the nonresident alien is treated as a resident alien by.29
reason of an election under section 6013(g) or (h). In addition,
if a student is a nonresident alien, a taxpayer may not claim an
education credit with respect to the qualified tuition and
related expenses of the student unless the student is a dependent
as defined in section 152. Among other requirements under
section 152, the nonresident alien student must be a resident of
a country contiguous to the United States in order to be treated
as a dependent.

�1.25A-2 Definitions.

(a) Claimed dependent. A claimed dependent means a
dependent (as defined in section 152) for whom a deduction under
section 151 is allowed on a taxpayer's federal income tax return
for the taxable year.

(b) Eligible educational institution--(1) In general. In
general, an eligible educational institution means a college,
university, vocational school, or other postsecondary educational
institution that is--
(i) Described in section 481 of the Higher Education Act of
1965 (20 U.S.C. 1088) as in effect on August 5, 1997, (generally
all accredited public, nonprofit, and proprietary postsecondary
institutions); and
(ii) Participating in a federal financial aid program under
title IV of the Higher Education Act of 1965 (20 U.S.C. 1070 et
seq.) or is certified by the Department of Education as eligible
to participate in such a program but chooses not to participate.

(2) Rules on federal financial aid programs. For rules.30
governing an educational institution's eligibility to participate
in federal financial aid programs, see 20 U.S.C. 1070 et seq.; 20
U.S.C. 1094; and 34 CFR 600 and 668.

(c) Academic period. Academic period means a quarter,
semester, trimester, or other period of study (such as a summer
school session) as reasonably determined by an eligible
educational institution.

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

Qualified tuition and related expenses means tuition and fees
required for the enrollment or attendance of a student for
courses of instruction at an eligible educational institution.

(2) Required fees--(i) In general. Except as provided in
paragraph (d)(3) of this section, the test for determining
whether any fee is a qualified tuition and related expense is
whether the fee is required to be paid to the eligible
educational institution as a condition of the student's
enrollment or attendance at the institution.

(ii) Books, supplies, and equipment. Qualified tuition and
related expenses include fees for books, supplies, and equipment
used in a course of study only if the fee must be paid to the
eligible educational institution for the enrollment or attendance
of the student at the institution.

(iii) Nonacademic fees. Except as provided in paragraph
(d)(3) of this section, qualified tuition and related expenses
include fees charged by an eligible educational institution that
are not used directly for, or allocated to, an academic course of.31
instruction only if the fee must be paid to the eligible
educational institution for the enrollment or attendance of the
student at the institution.

(3) Personal expenses. Qualified tuition and related
expenses do not include the costs of room and board, insurance,
medical expenses, transportation, and similar personal, living,
or family expenses, regardless of whether the fee must be paid to
the eligible educational institution for the enrollment or
attendance of the student at the institution.

(4) Treatment of comprehensive fees. If a student is
required to pay a comprehensive fee to an eligible educational
institution that includes charges for tuition, fees, and personal
expenses described in paragraph (d)(3) of this section, the
portion of the comprehensive fee that is allocable to personal
expenses is not a qualified tuition and related expense. The
allocation must be made by the institution using a reasonable
method.

(5) Hobby courses. Qualified tuition and related expenses
do not include expenses that relate to any course of instruction
or other education that involves sports, games, or hobbies, or
any noncredit course, unless the course or other education is
part of the student's degree program or, in the case of the
Lifetime Learning Credit, is taken by the student to acquire or
improve job skills.

(6) Examples. The following examples illustrate the rules
of this paragraph (d). In each example, assume that all other.32
relevant requirements to claim an education credit are met. The
examples are as follows:

Example 1. University V offers a degree program in
dentistry. In addition to tuition, all students enrolled in the
program are required to pay a fee to University V for the rental
of dental equipment. Because the equipment rental fee must be
paid to University V for enrollment and attendance, the tuition
and the equipment rental fee are qualified tuition and related
expenses.

Example 2. First-year students at College W are required to
obtain books and other reading materials used in its mandatory
first-year curriculum. The books and other reading materials are
not required to be purchased from College W and may be borrowed
from other students or purchased from off-campus bookstores, as
well as from College W's bookstore. College W bills students for
any books and materials purchased from College W's bookstore.

The fee that College W charges for the first-year books and
materials purchased at its bookstore is not a qualified tuition
and related expense because the books and materials are not
required to be purchased from College W for enrollment or
attendance at the institution.

Example 3. All students who attend College X are required
to pay a separate student activity fee in addition to their
tuition. The student activity fee is used solely to fund on-campus
organizations and activities run by students, such as the
student newspaper and the student government (no portion of the
fee covers personal expenses). Although labeled as a student
activity fee, the fee is required for enrollment or attendance at
College X. Therefore, the fee is a qualified tuition and related
expense.

Example 4. The facts are the same as in Example 3, except
that College X offers an optional athletic fee that students may
pay to receive discounted tickets to sports events. The athletic
fee is not required for enrollment or attendance at College X.

Therefore, the fee is not a qualified tuition and related
expense.

Example 5. College Y requires all students to live on
campus. It charges a single comprehensive fee to cover tuition,
required fees not allocable to personal expenses, and room and
board. Based on College Y's reasonable allocation, sixty percent
of the comprehensive fee is allocable to tuition and other
required fees not allocable to personal expenses, and the
remaining forty percent of the comprehensive fee is allocable to
charges for room and board. Therefore, only sixty percent of
College Y's comprehensive fee is a qualified tuition and related
expense..33
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.

�1.25A-3 Hope Scholarship Credit.

(a) Amount of the credit--(1) In general. Subject to the
phase out of the education credit described in �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
�1.25A-5(e)(2)); plus
(ii) 50 percent of the next $1,000 of such expenses paid
with respect to that student.

(2) Maximum credit. For taxable years beginning before
2002, the maximum Hope Scholarship Credit allowed for each
eligible student is $1,500. For taxable years beginning after
2001, the amounts in paragraph (a)(1) of this section to
determine the maximum credit will be increased for inflation
occurring after 2000 in accordance with section 1(f)(3). If any
amount adjusted under this paragraph (a)(2) is not a multiple of
$100, the amount will be rounded to the next lowest multiple of
$100..34
(b) Per student credit--(1) In general. A Hope Scholarship
Credit may be claimed for the qualified tuition and related
expenses of each eligible student (as defined in paragraph (d) of
this section).

(2) Example. The following example illustrates the rule of
this paragraph (b). In the example, assume that all the
requirements to claim an education credit are met. The example
is as follows:

Example. In 1999, Taxpayer A has two dependents, B and C,
both of whom are eligible students. Taxpayer A pays $1,600 in
qualified tuition and related expenses for dependent B to attend
a community college. Taxpayer A pays $5,000 in qualified tuition
and related expenses for dependent C to attend University X.

Taxpayer A may claim a Hope Scholarship Credit of $1,300 ($1,000
+ (.50 x $600)) for dependent B, and the maximum $1,500 Hope
Scholarship Credit for dependent C, for a total Hope Scholarship
Credit of $2,800.

(c) Credit allowed for only two taxable years. For each
eligible student, the Hope Scholarship Credit may be claimed for
no more than two taxable years.

(d) Eligible student--(1) Eligible student defined. For
purposes of the Hope Scholarship Credit, the term eligible
student means a student who satisfies all of the following
requirements--
(i) Degree requirement. For at least one academic period
that begins during the taxable year, the student enrolls at an
eligible educational institution in a program leading toward a
postsecondary degree, certificate, or other recognized
postsecondary educational credential;
(ii) Work load requirement. For at least one academic.35
period that begins during the taxable year, the student enrolls
for at least half of the normal full-time work load for the
course of study the student is pursuing. The standard for what
is half of the normal full-time work load is determined by each
eligible educational institution. However, the standard for
half-time may not be lower than standards for half-time
established by the Department of Education under the Higher
Education Act of 1965 and set forth in 34 CFR 674.2(b) for a
half-time undergraduate student;
(iii) Year of study requirement. As of the beginning of the
taxable year, the student has not completed the first two years
of postsecondary education at an eligible educational
institution. Whether a student has completed the first two years
of postsecondary education at an eligible educational institution
as of the beginning of a taxable year is determined based on
whether the institution in which the student is enrolled in a
degree program (as described in paragraph (d)(1)(i) of this
section) awards the student two years of academic credit at that
institution for postsecondary course work completed by the
student prior to the beginning of the taxable year. Any academic
credit awarded by the eligible educational institution solely on
the basis of the student's performance on proficiency
examinations is disregarded in determining whether the student
has completed two years of postsecondary education; and
(iv) No felony drug conviction. The student has not been
convicted of a federal or state felony offense for possession or.36
distribution of a controlled substance as of the end of the
taxable year for which the credit is claimed.

(2) Examples. The following examples illustrate the rules
of this paragraph (d). In each example, assume that the student
has not been convicted of a felony drug offense, that the
institution is an eligible educational institution unless
otherwise stated, that the qualified tuition and related expenses
are paid during the same taxable year that the academic period
begins, and that a Hope Scholarship Credit has not previously
been claimed for the student (see paragraph (c) of this section).

The examples are as follows:

Example 1. Student A graduates from high school in June
1998 and enrolls full-time in an undergraduate degree program at
College U for the 1998 Fall semester. For the 1999 Spring
semester, Student A again enrolls at College U on a full-time
basis. For the 1999 Fall semester, Student A enrolls in less
than half the normal full-time course work for her degree
program. Because Student A is enrolled in an undergraduate
degree program on at least a half-time basis for at least one
academic period that begins during 1998 and at least one academic
period that begins during 1999, Student A is an eligible student
for taxable years 1998 and 1999 (including the 1999 Fall semester
when Student A enrolls at College U on less than a half-time
basis).

Example 2. Prior to 1998, Student B attended college for
several years on a full-time basis. Student B transfers to
College V for the 1998 Spring semester. College V awards Student
B credit for some (but not all) of the courses he previously
completed, and College V classifies Student B as a first-semester
sophomore. During both the Spring and Fall semesters of 1998,
Student B enrolls in half the normal full-time work load for his
degree program. Because College V does not classify Student B as
having completed the first two years of postsecondary education
as of the beginning of 1998, Student B is an eligible student for
taxable year 1998.

Example 3. The facts are the same as in Example 2. After
taking classes on a half-time basis for the 1998 Spring and Fall
semesters, Student B enrolls in a full-time work load at College
V for the 1999 Spring semester. College V classifies Student B.37
as a second-semester sophomore for the 1999 Spring semester and
as a first-semester junior for the 1999 Fall semester. Because
College V does not classify Student B as having completed the
first two years of postsecondary education as of the beginning of
1999, Student B is an eligible student for taxable year 1999.

Example 4. At the time that Student C enrolls in a degree
program at College W for the 1998 Fall semester, Student C takes
examinations to demonstrate her proficiency in several subjects.

On the basis of Student C's performance on these examinations,
College W classifies Student C as a second-semester sophomore as
of the beginning of the 1998 Fall semester. Student C takes a
full-time work load during the 1998 Fall semester and during the
1999 Spring and Fall semesters. Because Student C was not
enrolled in a college or other eligible educational institution
prior to 1998 (but rather was classified as a second-semester
sophomore by College W as of the start of the 1998 Fall semester
solely because of proficiency examinations), Student C is not
treated as having completed the first two years of postsecondary
education at an eligible educational institution as of the
beginning of 1998 or as of the beginning of 1999. Therefore,
Student C is an eligible student for both taxable years 1998 and
1999.

Example 5. During the 1998 Fall semester, Student D is a
high school student who takes classes on a half-time basis at
College X. Student D is not enrolled as part of a degree program
at College X because College X does not admit students to a
degree program unless the student has a high school diploma or
equivalent. Because Student D is not enrolled in a degree
program at College X during 1998, Student D is not an eligible
student for taxable year 1998.

Example 6. The facts are the same as in Example 5. During
the 1999 Spring semester, Student D again attends College X but
not as part of a degree program. Student D graduates from high
school in June 1999. For the 1999 Fall semester, Student D
enrolls in College X as part of a degree program, and College X
awards Student D credit for her prior course work at College X.

During the 1999 Fall semester, Student D takes more than half the
normal full-time work load of courses for her degree program at
College X. Because Student D is enrolled in a degree program at
College X for the 1999 Fall term on more than a half-time basis,
Student D is an eligible student for all of taxable year 1999.

Therefore, the qualified tuition and required fees paid for
classes taken at College X during both the 1999 Spring semester
(during which Student D was not enrolled in a degree program) and
the 1999 Fall semester are taken into account in computing any
Hope Scholarship Credit.

Example 7. Student E completed two years of undergraduate
study at College S located in Country S. College S is not an.38
eligible educational institution for purposes of the education
credits. At the end of 1998, Student E moves to the United
States and enrolls in an undergraduate degree program at College
Z on a full-time basis for the 1999 Spring semester. College Z
awards Student E two years of academic credit for his previous
course work at College S and classifies Student E as a first-semester
junior for the 1999 Spring semester. Student E is
treated as having completed the first two years of postsecondary
education at an eligible educational institution as of the
beginning of 1999. Therefore, Student E is not an eligible
student for taxable year 1999.

Example 8. Student F was born and raised in Country R, and
she received a degree in 1998 from College R located in Country
R. College R is not an eligible educational institution for
purposes of the education credits. During 1999, Student F moves
to the United States and enrolls for the 1999 Fall semester on a
full-time basis in a graduate-degree program at College Y. By
admitting Student F to its graduate degree program, College Y
treats Student F as having completed the first two years of
postsecondary education as of the beginning of 1999. Therefore,
Student F is not an eligible student for taxable year 1999.

(e) Academic period for prepayments--(1) In general. For
purposes of determining whether a student meets the requirements
in paragraph (d) of this section for a taxable year, if qualified
tuition and related expenses are paid during one taxable year for
an academic period that begins during January, February or March
of the next taxable year (for taxpayers on a fiscal taxable year,
use the first three months of the next taxable year), the
academic period is treated as beginning during the taxable year
in which the payment is made.

(2) Example. The following example illustrates the rule of
this paragraph (e). In the example, assume that all the
requirements to claim a Hope Scholarship Credit are met. The
example is as follows:

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

After graduation, Student G works full-time for several months to
earn money for college. Student G enrolls full-time in an.39
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.

�1.25A-4 Lifetime Learning Credit.

(a) Amount of the credit--(1) Taxable years beginning before
January 1, 2003. Subject to the phase out of the education
credit described in �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 �1.25A-5(e)(2)).

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

Subject to the phase out of the education credit described in
�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.40
spouse, and any claimed dependent during any academic period
beginning in the taxable year (or treated as beginning in the
taxable year, see �1.25A-5(e)(2)).

(3) Coordination with the Hope Scholarship Credit. Expenses
paid with respect to a student for whom the Hope Scholarship
Credit is claimed are not eligible for the Lifetime Learning
Credit.

(4) Examples. The following examples illustrate the rules
of this paragraph (a). In each example, assume that all the
requirements to claim a Lifetime Learning Credit or a Hope
Scholarship Credit, as applicable, are met. The examples are as
follows:

Example 1. In 1999, Taxpayer A pays qualified tuition and
related expenses of $3,000 for dependent B to attend an eligible
educational institution, and he pays qualified tuition and
related expenses of $4,000 for dependent C to attend an eligible
educational institution. Taxpayer A does not claim a Hope
Scholarship Credit with respect to either B or C. Although
Taxpayer A paid $7,000 of qualified tuition and related expenses
during the taxable year, Taxpayer A may claim the Lifetime
Learning Credit with respect to only $5,000 of such expenses.

Therefore, the maximum Lifetime Learning Credit Taxpayer A may
claim for 1999 is $1,000 (.20 x $5,000).

Example 2. In 1999, Taxpayer D pays $6,000 of qualified
tuition and related expenses for dependent E, and $2,000 of
qualified tuition and related expenses for dependent F, to attend
eligible educational institutions. Dependent F has already
completed the first two years of postsecondary education. For
1999, Taxpayer D claims the maximum $1,500 Hope Scholarship
Credit with respect to dependent E. In computing the amount of
the Lifetime Learning Credit, Taxpayer D may not include any of
the $6,000 of qualified tuition and related expenses paid on
behalf of dependent E but may include the $2,000 of qualified
tuition and related expenses of dependent F.

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

There is no limit to the number of taxable years that a taxpayer.41
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.

�1.25A-5 Special rules relating to characterization and timing of
payments..42
(a) Payments of educational expenses by a third party--(1)
In general. Solely for purposes of section 25A, if a third party
(someone other than the taxpayer, the taxpayer's spouse, or a
claimed dependent) makes a payment directly to an eligible
educational institution to pay for a student's qualified tuition
and related expenses, the student is treated as receiving the
payment from the third party, and, in turn, paying the qualified
tuition and related expenses to the institution.

(2) Example. The following example illustrates the rule of
this paragraph (a). In the example, assume that all the
requirements to claim an education credit are met. The example
is as follows:

Example. Grandparent D makes a direct payment to an
eligible educational institution for Student E's qualified
tuition and related expenses. Student E is not a claimed
dependent in 1999. For purposes of claiming an education credit,
Student E is treated as receiving the money from her grandparent
and, in turn, paying her qualified tuition and related expenses.

(b) Expenses paid by dependent--(1) In general. Qualified
tuition and related expenses paid by a student are treated as
paid by a taxpayer if the student is a claimed dependent of the
taxpayer for the taxable year in which the expenses are paid.

(2) Example. The following example illustrates the rule of
this paragraph (b). In the example, assume that all the
requirements to claim an education credit are met. The example
is as follows:

Example. Under a court-approved divorce decree, Parent A is
required to pay Student C's college tuition. Parent A makes a
direct payment to an eligible educational institution for Student
C's 1999 tuition. Under paragraph (a) of this section, Student C
is treated as receiving the money from Parent A and, in turn,.43
paying his qualified tuition and related expenses. Under the
divorce decree, Parent B has custody of Student C for 1999.

Parent B properly claims Student C as a dependent on Parent B's
1999 federal income tax return. Parent B may claim an education
credit for the qualified tuition and related expenses paid
directly to the institution by Parent A.

(c) Adjustment to qualified tuition and related expenses for
certain excludable educational assistance--(1) In general. In
determining the amount of an education credit, qualified tuition
and related expenses paid during the taxable year must be reduced
by any amount paid to, or on behalf of, a student during the
taxable year with respect to attendance at an eligible
educational institution during an academic period beginning in
that taxable year that is--
(i) A qualified scholarship that is excludable from income
under section 117;
(ii) A veterans' or member of the armed forces' educational
assistance allowance under chapter 30, 31, 32, 34 or 35 of title
38, United States Code, or under chapter 1606 of title 10, United
States Code;
(iii) Employer-provided educational assistance that is
excludable from income under section 127; or
(iv) Any other educational assistance that is excludable
from gross income (other than as a gift, bequest, devise, or
inheritance within the meaning of section 102(a)).

(2) No adjustment for excludable educational assistance
attributable to expenses paid in a prior year. A reduction is
not required under paragraph (c)(1) of this section if the amount
of excludable educational assistance received during the taxable.44
year is treated as a refund of qualified tuition and related
expenses paid in a prior taxable year. See paragraph (f)(4) of
this section.

(3) Allocation of scholarships and fellowship grants. For
purposes of paragraph (c)(1) of this section, a scholarship or
fellowship grant is treated as a qualified scholarship excludable
from income under section 117 unless--
(i) The student reports the grant as income on the student's
federal income tax return; or
(ii) The grant must be applied, by its terms, to expenses
other than qualified tuition and related expenses within the
meaning of section 117(b)(2), such as room and board.

(4) Examples. The following examples illustrate the rules
of this paragraph (c). In each example, assume that all the
requirements to claim an education credit are met. The examples
are as follows:

Example 1. University X charges Student A, who lives on X's
campus, $3,000 for tuition and $5,000 for room and board.

University X awards a $2,000 scholarship to Student A, which
University X applies against Student A's $8,000 total bill. The
terms of the scholarship permit it to be used to pay any of a
student's costs of attendance at University X, including tuition
and room and board. Student A pays the $6,000 balance of her
bill from University X with a combination of savings and amounts
she earns from a summer job. University X does not require A to
pay any additional fees beyond the $3,000 in tuition in order to
enroll in classes. Student A does not report any portion of the
scholarship as income on Student A's federal income tax return.

The scholarship is a qualified scholarship that is excludable
from Student A's income under section 117 and is allocable first
to Student A's qualified tuition and related expenses.

Therefore, for purposes of calculating an education credit,
Student A is treated as having paid only $1,000 ($3,000 tuition -$
2,000 scholarship) in qualified tuition and related expenses to
University X..45
Example 2. The facts are the same as in Example 1, except
that in addition to the scholarship that University X awards to
Student A, University X also provides Student A with a student
loan and pays Student A for working in a work/study job in the
campus dining hall. The loan is not excludable educational
assistance. In addition, wages paid to a student who is
performing services for the payor are neither a qualified
scholarship nor otherwise excludable from gross income.

Therefore, Student A is not required to reduce her qualified
tuition and related expenses by the amounts she receives from the
student loan or as wages from her work/study job.

Example 3. In 1999, Student B pays University Y $1,000 in
tuition for the 1999 Spring semester. University Y does not
require Student B to pay any additional fees beyond the $1,000 in
tuition in order to enroll in classes. Student B is an employee
of Company Z. At the end of the academic period and during the
same taxable year that Student B paid tuition to University Y,
Student B provides Company Z with proof that he has
satisfactorily completed his courses at University Y. Pursuant
to an educational assistance program described in section 127(b),
Company Z reimburses Student B for all of the tuition paid to
University Y. Because the reimbursement from Company Z is
employer-provided educational assistance that is excludable from
Student B's gross income under section 127, the reimbursement
reduces Student B's qualified tuition and related expenses.

Therefore, for purposes of calculating an education credit,
Student B is treated as having paid no qualified tuition and
related expenses to University Y during 1999.

Example 4. The facts are the same as in Example 3, except
that the reimbursement from Company Z is not pursuant to an
educational assistance program described in section 127(b), is
not otherwise excludable from Student B's gross income, and is
taxed as additional wages to Student B. Because the
reimbursement is not excludable employer-provided educational
assistance, Student B is not required to reduce his qualified
tuition and related expenses by the $1,000 reimbursement he
received from his employer. Therefore, for purposes of
calculating an education credit, Student B is treated as paying
$1,000 in qualified tuition and related expenses to University Y
during 1999.

(d) No double benefit. Qualified tuition and related
expenses do not include any expense for which a deduction is
allowed under section 162 or any other provision of chapter 1 of
the Internal Revenue Code.

(e) Timing rules--(1) In general. Except as provided in.46
paragraph (e)(2) of this section, an education credit is allowed
only for payments of qualified tuition and related expenses for
an academic period beginning in the same taxable year as the year
the payment is made. Except for certain individuals who do not
use the cash receipts and disbursements method of accounting,
qualified tuition and related expenses are treated as paid in the
year in which the expenses are actually paid. See �1.461-
1(a)(1).

(2) Prepayment rule--(i) In general. If qualified tuition
and related expenses are paid during one taxable year for an
academic period that begins during the first three months of the
taxpayer's next taxable year (i.e., in January, February, or
March of the next taxable year for calendar year taxpayers), an
education credit is allowed with respect to the qualified tuition
and related expenses only in the taxable year in which the
expenses are paid.

(ii) Example. The following example illustrates the rule of
this paragraph (e)(2). In the example, assume that all the
requirements to claim an education credit are met. The example
is as follows:

Example. In December 1998, Taxpayer A, a calendar year
taxpayer, pays College Z $1,000 in qualified tuition and related
expenses to attend the 1999 Spring semester, which begins in
January 1999. Taxpayer A may claim an education credit only in
1998 for payments made in 1998 for the 1999 Spring semester.

(3) Expenses paid with loan proceeds. An education credit
may be claimed for the qualified tuition and related expenses
paid with the proceeds of a loan only in the taxable year in.47
which the expenses are paid, and may not be claimed in the
taxable year in which the loan is repaid. Loan proceeds
disbursed directly to an eligible educational institution will be
treated as paid on the date of disbursement. If a taxpayer does
not know the date of disbursement, the taxpayer must treat the
qualified tuition and related expenses as paid on the last date
for payment prescribed by the institution.

(f) Refund of qualified tuition and related expenses--(1)
Payment and refund of qualified tuition and related expenses in
the same taxable year. With respect to any student, the amount
of qualified tuition and related expenses for a taxable year is
calculated by adding all qualified tuition and related expenses
paid for the taxable year, and subtracting any refund of such
expenses received from the eligible educational institution
during the same taxable year.

(2) Payment of qualified tuition and related expenses in one
taxable year and refund in subsequent taxable year before return
filed for prior taxable year. If, in a taxable year, a taxpayer,
(or the taxpayer's spouse or a claimed dependent) receives a
refund from an eligible educational institution of qualified
tuition and related expenses paid in a prior taxable year and the
refund is received before the taxpayer files a federal income tax
return for the prior taxable year, the amount of the qualified
tuition and related expenses for the prior taxable year is
reduced by the amount of the refund.

(3) Payment of qualified tuition and related expenses in one.48
taxable year and refund in subsequent taxable year--(i) In
general. If, in a taxable year (refund year), a taxpayer (or the
taxpayer's spouse or a claimed dependent) receives a refund of
qualified tuition and related expenses for which the taxpayer
claimed an education credit in a prior taxable year, the tax
imposed by chapter 1 of the Internal Revenue Code for the refund
year is increased by the recapture amount.

(ii) Recapture amount. The recapture amount is the
difference between the credit claimed in the prior taxable year
and the redetermined credit. The redetermined credit is computed
by reducing the amount of the qualified tuition and related
expenses for which a credit was claimed in the prior taxable year
by the amount of the refund of the qualified tuition and related
expenses (redetermined qualified expenses), and computing the
credit using the redetermined qualified expenses and the relevant
facts and circumstances of the prior taxable year, such as
modified adjusted gross income (redetermined credit). Any
redetermination of the tax liability for the prior taxable year
(by audit or amended return) will be taken into account in
computing the redetermined credit.

(4) Excludable educational assistance received in a
subsequent taxable year treated as a refund. If, in a taxable
year, any excludable educational assistance (described in
paragraph (c)(1) of this section) is received for the qualified
tuition and related expenses paid during a prior taxable year (or
attributable to enrollment at an eligible educational institution.49
during a prior taxable year), the educational assistance is
treated as a refund of qualified tuition and related expenses for
purposes of paragraphs (f)(2) and (3) of this section. If a
taxpayer (or the taxpayer's spouse or a claimed dependent)
receives any excludable educational assistance before the
taxpayer files a federal income tax return for the prior taxable
year, the amount of the qualified tuition and related expenses
for the prior taxable year is reduced by the amount of the
excludable educational assistance as provided in paragraph (f)(2)
of this section. If a taxpayer (or the taxpayer's spouse or a
claimed dependent) receives excludable educational assistance
after the taxpayer has filed a federal income tax return for the
prior taxable year, any education credit claimed for the prior
taxable year is subject to recapture as provided in paragraph
(f)(3) of this section.

(5) Examples. The following examples illustrate the rules
of this paragraph (f). In each example, assume that all the
requirements to claim an education credit are met. The examples
are as follows:

Example 1. In January 1998, Student A, a full-time freshman
at University X, pays $2,000 for qualified tuition and related
expenses for a 16-hour work load for the 1998 Spring semester.

Prior to beginning classes, Student A withdraws from 6 course
hours. On February 15, 1998, Student A receives an $800 refund
from University X. In September 1998, Student A pays University
X $1,000 to enroll half-time for the 1998 Fall semester. Prior
to beginning classes, Student A withdraws from a 2-hour course,
and she receives a $200 refund in October 1998. Student A
computes the amount of qualified tuition and related expenses she
may claim for 1998 by:

(i) Adding all qualified expenses paid during the taxable
year ($2,000 + 1,000 = $3,000);.50
(ii) Adding all refunds of qualified tuition and related
expenses received during the taxable year ($800 + $200 = $1,000);
and, then
(iii) Subtracting (ii) from (i) ($3,000 - $1,000 = $2,000).

Therefore, Student A's qualified tuition and related expenses for
1998 are $2,000..Example 2. (i) In December 1998, Student B, a senior at
College Y, pays $2,000 for qualified tuition and related expenses
for a 16-hour work load for the 1999 Spring semester. Prior to
beginning classes, Student B withdraws from a 4-hour course. On
January 15, 1999, Student B files her 1998 income tax return and
claims a $400 Lifetime Learning Credit for the $2,000 qualified
expenses paid in 1998.

(ii) She calculates the increase in tax for 1999 by:

(A) Calculating the redetermined qualified expenses
($2,000 - $500 = $1,500);
(B) Calculating the redetermined credit for the redetermined
qualified expenses ($1,500 x .20 = $300); and
(C) Subtracting the redetermined credit from the credit
claimed in 1998 ($400 - $300 = $100).

(iii) Therefore, Student B must increase the tax on her 1999
federal income tax return by $100.

Example 3. In September 1998, Student C pays College Z
$1,200 in qualified tuition and related expenses to attend
evening classes during the 1998 Fall semester. Student C is an
employee of Company R. On January 15, 1999, Student C files a
federal income tax return for 1998 claiming a Lifetime Learning
Credit of $240 (.20 x $1,200). Pursuant to an educational
assistance program described in section 127(b), Company R
reimburses Student C in February 1999 for the $1,200 of qualified
tuition and related expenses paid by Student C in 1998. The $240
education credit claimed by Student C for 1998 is subject to
recapture. Because Student C paid no net qualified tuition and
related expenses in 1998, the redetermined credit for 1998 is
zero. Student C must increase the amount of Student C's 1999
taxes by the recapture amount, which is $240 (the education
credit claimed for 1998 ($240) minus the redetermined credit for
1998 ($0)). Because the $1,200 reimbursement is taken into
account in calculating the $240 recapture amount for 1999, the
reimbursement does not reduce the amount of any qualified tuition
and related expenses that Student C paid in 1999.

Deputy Commissioner of Internal Revenue

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