US Education Credits 8863

US Education Credits and Education Savings — Form 8863 and Related

Tax year 2025. Federal only. Sole proprietors, single-member LLCs disregarded for federal tax, and other individual filers in scope. State-level education benefits (e.g., NY 529 deduction, CA scholarship rules) are out of scope here.

1. Scope and Refusal Catalogue

1.1 In scope

• American Opportunity Tax Credit (AOTC) under IRC §25A(i)
• Lifetime Learning Credit (LLC) under IRC §25A(c)
• Student loan interest deduction under IRC §221
• §529 Qualified Tuition Programs — contributions, distributions, K-12 expansion, postsecondary credentialing expenses, apprenticeship and student loan use, the SECURE 2.0 §126 529-to-Roth rollover
• Coverdell Education Savings Accounts (ESA) under IRC §530
• Tax treatment of scholarships under IRC §117
• Employer-provided educational assistance under IRC §127
• Form 8863 preparation
• Coordination rules among AOTC, LLC, 529, scholarships, and tax-free employer assistance
• Form 1098-T reconciliation

1.2 Out of scope (refuse and refer)

• The Tuition and Fees Deduction under former §222 — permanently repealed for tax years after 2020 by the Consolidated Appropriations Act, 2021 (P.L. 116-260, Div. EE §104). Do not compute. If a 2025 client asks, explain repeal and pivot to AOTC/LLC.
• §117(d) qualified tuition reduction for employees of educational institutions — narrow, refer to specialist.
• §501(c)(3) institutional tax issues (school's perspective).
• State income tax deductions for 529 contributions — varies by state (~35 states allow; NY $5k/$10k MFJ, CA none, MA $1k/$2k MFJ). Refer to state skill if loaded.
• Non-resident alien education taxation — refer to ITIN/1040-NR specialist.
• ABLE accounts under §529A — separate skill.
• Public Service Loan Forgiveness (PSLF) income exclusion mechanics — refer to specialist.
• Cancellation of student loan debt under §108(f) — refer to insolvency/cancellation-of-debt skill.
• Education-related Saver's Credit interactions for retirement contributions — covered under us-self-employed-retirement.
• Two-year-college vocational rehabilitation grant analysis under §117(c) where research/teaching service is required.

1.3 Conservative defaults

• Half-time enrollment unverified — If half-time enrollment is unverified, assume not half-time and disallow AOTC; permit LLC if otherwise qualified. (unsure - no citation provided)
• Possible felony drug conviction — If a felony drug conviction is possible (mentioned, not denied), require client written confirmation; AOTC denied if affirmative. (unsure - no citation provided)
• 1098-T Box 1 vs family records disagree — If 1098-T Box 1 (payments received) and the family's records disagree, prefer the smaller of the two unless the larger is substantiated with cancelled checks or institution statements. (unsure - no citation provided)
• 529 distributions cover same expenses as AOTC — If 529 distributions cover same expenses claimed for AOTC, reduce AOTC base by the tax-free 529 portion before computing the credit. (unsure - no citation provided)

2. American Opportunity Tax Credit (AOTC) — IRC §25A(i)

2.1 Headline numbers (2025)

AOTC headline numbers 2025 (§25A(i))

Item	Value	Source
Maximum credit per eligible student	$2,500	§25A(i)(1)
100% credit on first	$2,000 of qualified expenses	§25A(i)(1)(A)
25% credit on next	$2,000 of qualified expenses	§25A(i)(1)(B)
Refundable portion	40% of credit (max $1,000)	§25A(i)(6)
MAGI phaseout — single/HoH	$80,000 to $90,000	§25A(i)(4); not indexed
MAGI phaseout — MFJ/QSS	$160,000 to $180,000	§25A(i)(4); not indexed
Maximum years per student	4 tax years	§25A(i)(2)

• AOTC phaseout thresholds not indexed — The AOTC phaseout thresholds are not indexed for inflation. They have been $80k/$160k since 2009 (American Recovery and Reinvestment Act §1004) and remain so under OBBBA (P.L. 119-21, July 4, 2025) for tax year 2025. This is a frequent error point — practitioners assume CPI indexing. (American Recovery and Reinvestment Act §1004; OBBBA P.L. 119-21)

2.2 Computation walkthrough

• Step 1 - Aggregate QEE — Aggregate qualified education expenses (QEE) paid in 2025 for the student. QEE = tuition + required enrollment fees + course materials (books, supplies, equipment) whether or not paid to the institution. Not room and board, not transportation, not insurance, not medical, not personal living expenses. (unsure - no citation provided)
• Step 2 - Reduce QEE — Reduce QEE by: Tax-free scholarships and grants applied to that student for that year (unless the family elects to make a scholarship taxable — see §6.2); Tax-free 529/Coverdell distributions applied to the same expenses; Tax-free employer §127 assistance applied to the same expenses; Veterans' education benefits applied to those expenses. (unsure - no citation provided)
• Step 3 - Apply 100/25 brackets — 100% × min(QEE, $2,000) + 25% × min(max(QEE - $2,000, 0), $2,000). Cap at $2,500. (unsure - no citation provided)
• Step 4 - MAGI phaseout — If MAGI is between the thresholds, multiply the credit by (upper threshold − MAGI) / $10,000 (single) or / $20,000 (MFJ). (unsure - no citation provided)
• Step 5 - Split refundable vs nonrefundable — 40% refundable (Part I of Form 8863), 60% nonrefundable (Part II). (unsure - no citation provided)
• Step 6 - Kiddie exception — Refundable portion is denied to a taxpayer who is a child under §1(g)(2) (the kiddie tax rules) and meets certain conditions — typically a child under 18, or under 24 if a full-time student with earned income ≤ half of support. The nonrefundable portion is still allowed. See §25A(i)(6)(B). (§25A(i)(6)(B))

2.3 Eligibility — five hard tests

• Intro to five hard tests — The student must satisfy all of the following for the credit year (§25A(b)(2) and (i)). (§25A(b)(2) and (i))
• Test 1 - Degree or credential — Pursuing a degree, certificate, or other recognized credential. (§25A(b)(2) and (i))
• Test 2 - Enrollment intensity — Enrolled at least half-time for at least one academic period beginning in the tax year. (§25A(b)(2) and (i))
• Test 3 - First-four-years rule — Has not completed the first four years of post-secondary education before 2025. (§25A(b)(2) and (i))
• Test 4 - Prior-year limit — AOTC (or its predecessor Hope Credit) has not been claimed for this student for any 4 prior tax years. (§25A(b)(2) and (i))
• Test 5 - No felony drug conviction — Has not been convicted of a felony for possession or distribution of a controlled substance as of the end of the tax year. (§25A(b)(2) and (i))
• TIN and 2026 SSN requirement — For 2025, Form 8863 requires the relevant TINs by the due date of the return, including extensions. For AOTC, both the filer and student must have TINs by the due date; for LLC, the student must have a TIN by the due date. Beginning with taxable years after 2025, P.L. 119-21 §70606 requires Social Security numbers, as defined by §24(h)(7), for the claimant and, when the credit is for another student, that student; omission can be treated as a math or clerical error. (Form 8863 instructions; IRC §25A(g)(1); P.L. 119-21 §70606)

2.4 Eligible educational institution

• Eligible educational institution — Any college, university, vocational school, or other post-secondary institution eligible to participate in a Federal Student Aid program under Title IV of the Higher Education Act of 1965. Confirm via the institution's appearance on the Federal School Code list. Foreign institutions can qualify if Title IV-eligible. (unsure - no citation provided)

2.5 Who claims the credit

• Dependent student — If the student is claimed as a dependent, only the parent (or the taxpayer claiming the dependent) may claim the credit, and the expenses paid by the dependent are treated as paid by the taxpayer. (unsure - no citation provided)
• Non-dependent student — If the student is not claimed as a dependent (even if the parent could have claimed), the student claims the credit on the student's own return — and may even claim the refundable portion if not subject to the kiddie-tax exception. (unsure - no citation provided)

Strategic planning: When the parent is phased out of AOTC by MAGI, sometimes it is better to not claim the student as a dependent, letting the student claim the AOTC (the student's MAGI is usually low). The parent loses the $500 credit for other dependents but gains up to $2,500 in AOTC. Run both scenarios.

2.6 AUDIT FLASH POINT — AOTC claimed for graduate school

• Graduate study ineligible for AOTC — Graduate study is never eligible for AOTC. AOTC is limited to the first four years of post-secondary education. A student in year 5+ of undergrad, an MBA student, a JD/MD student, or any master's/doctoral student is ineligible for AOTC. The IRS Pre-Refund Wage and Investment program targets AOTC for grad-school claims via 1098-T matching (Box 8 'at least half time' and Box 9 'graduate student'). If 1098-T Box 9 is checked, AOTC must not be claimed — LLC only. Document this in the workpapers explicitly. (unsure - no citation provided)

2.7 Other common AOTC errors

• Claiming AOTC for a 5th-year undergraduate (years, not academic years — count tax years AOTC/Hope was claimed).
• Claiming AOTC for a non-degree student (continuing education / certificate-only without degree pursuit).
• Including room and board (never qualified for AOTC).
• Including the cost of an off-campus apartment lease, parking, or commuting.
• Including health insurance premiums or student health fees that are optional.
• Claiming AOTC for a high school dual-enrollment student before HS graduation — generally allowed if degree-seeking and meeting all five tests, but unusual; document carefully.
• Failing to require a Form 1098-T (§6050S(d)) before claiming the credit. AOTC requires a 1098-T was received from the institution unless the institution is not required to issue one (e.g., foreign Title IV-eligible schools, or schools waiving 1098-T for certain student categories). See §25A(g)(8).

3. Lifetime Learning Credit (LLC) — IRC §25A(c)

3.1 Headline numbers (2025)

LLC headline numbers 2025 (§25A(c)(1); §25A(d))

Item	Value	Source
Maximum credit per return (not per student)	$2,000	§25A(c)(1)
Rate	20% of qualified expenses	§25A(c)(1)
Maximum qualified expenses per return	$10,000	§25A(c)(1)
Refundable portion	$0 — entirely nonrefundable	§25A(c)
MAGI phaseout — single/HoH	$80,000 to $90,000	§25A(d) as modified by Consolidated Appropriations Act 2021
MAGI phaseout — MFJ/QSS	$160,000 to $180,000	§25A(d) as modified by Consolidated Appropriations Act 2021

• LLC phaseout conformed to AOTC phaseout — The Consolidated Appropriations Act, 2021 (P.L. 116-260, Div. EE §104) conformed the LLC phaseout to the AOTC phaseout beginning in 2021. Before 2021 the LLC phaseout was lower ($59k/$118k MFJ for 2020). Both thresholds are now non-indexed. (P.L. 116-260, Div. EE §104)

3.2 What qualifies for LLC

• LLC QEE definition — QEE for LLC = tuition + required enrollment fees only. Course materials (books, supplies) qualify only if they are required to be paid to the institution as a condition of enrollment. This is the key difference from AOTC, which covers books/supplies bought anywhere. (unsure - no citation provided)
• LLC broader enrollment rules — LLC is broader than AOTC on the enrollment side: No degree or credential requirement. No minimum enrollment intensity (a single course qualifies). No four-year limit; LLC can be claimed for unlimited years. No first-four-years limit; grad school, professional school, continuing education, single job-skill courses all qualify. No felony drug conviction disqualifier. Includes courses to acquire or improve job skills, even if the student is not pursuing a degree. (unsure - no citation provided)

3.3 Per-return cap

• LLC per-return cap vs AOTC per-student — LLC is capped at $2,000 per return, not per student. A family with three students taking eligible coursework still gets at most $2,000 total LLC. By contrast AOTC is per student, so a family with three AOTC-eligible students can get up to $7,500 ($2,500 × 3). (unsure - no citation provided)

3.4 Choosing LLC vs AOTC per student

• Cannot claim both for same student — A student cannot have both AOTC and LLC claimed in the same tax year. But within one return, one student can be AOTC and another student can be LLC. (unsure - no citation provided)
• Algorithm for choosing — 1. For each student, determine whether the student is AOTC-eligible (all five hard tests). 2. If AOTC-eligible, AOTC is almost always better (up to $2,500 with refundable portion vs $2,000 nonrefundable cap shared across all students). 3. If not AOTC-eligible (grad student, more than 4 years prior, less than half-time, felony drug conviction, etc.), use LLC. 4. If multiple non-AOTC-eligible students, pool their expenses into LLC up to $10,000. (unsure - no citation provided)

4. AOTC vs LLC Quick-Reference

AOTC vs LLC quick reference (unsure - no citation provided)

Feature	AOTC	LLC
Maximum credit	$2,500 per student	$2,000 per return
Refundable	40% (up to $1,000)	No
Years available	4 tax years per student	Unlimited
Education level	First 4 years post-secondary	Any post-secondary, including grad
Enrollment intensity	At least half-time	Any (one course OK)
Degree requirement	Must pursue degree/credential	None
Felony drug conviction	Disqualifies	No restriction
Course materials	Qualified (anywhere bought)	Only if required institution fee
MAGI phaseout single	$80k–$90k	$80k–$90k
MAGI phaseout MFJ	$160k–$180k	$160k–$180k
Form 8863 part	Parts I (refundable) + II (nonrefundable)	Part II only
Form 8863 line for student	Part III	Part III

5. Student Loan Interest Deduction — IRC §221

5.1 Headline numbers (2025)

§221 headline numbers 2025 (§221; Pub. 970 (2025))

Item	Value	Source
Maximum deduction	$2,500	§221(b)(1)
Above-the-line	Yes — Schedule 1 line 21	§62(a)(17); Pub. 970
MAGI phaseout — single/HoH	$85,000 to $100,000 for 2025	Pub. 970 (2025)
MAGI phaseout — MFJ	$170,000 to $200,000 for 2025	Pub. 970 (2025)
MFS	Not allowed	§221(e)(2)

• §221 thresholds inflation-indexed - verify — The §221 thresholds are inflation-indexed under §221(f) (rounded to $5,000). For tax year 2025 the values above are estimated; verify against Rev. Proc. 2024-40 before filing. Do not rely on memory for the exact 2025 numbers — pull the published Rev. Proc. into the workpapers and cite the page. (§221(f); Rev. Proc. 2024-40)

5.2 What qualifies

• Qualified education loan definition — A 'qualified education loan' under §221(d) is any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses that: Are incurred on behalf of the taxpayer, spouse, or any dependent at the time the indebtedness was incurred; Are paid or incurred within a reasonable period of time before or after the indebtedness is incurred; and Are attributable to education furnished during a period during which the recipient was an eligible student (half-time+, degree/credential-seeking). (§221(d))
• Loan types qualifying/not qualifying — Federal student loans, private student loans, refinanced student loans, and consolidation loans all qualify. Loans from related parties (parent, sibling) and loans under qualified employer plans (§401(k) loans) do not qualify. (unsure - no citation provided)

5.3 Who can claim

• Who can claim §221 deduction — The taxpayer who is legally obligated to pay the loan and actually pays the interest. A parent who pays interest on a child's loan that the child is legally obligated for does not get the deduction; but if the parent is co-signer (legally obligated), the parent qualifies. Conversely, a child legally obligated whose parent pays the interest may be treated as if the child paid (gift from parent), and the child gets the deduction — but only if the child is not claimed as a dependent. (unsure - no citation provided)

5.4 Form mechanics

• 1098-E and Schedule 1 mechanics — The lender issues Form 1098-E if interest paid is $600 or more. The taxpayer deducts the interest on Schedule 1 Line 21. No separate form 8863 entry — this is independent of AOTC/LLC. (unsure - no citation provided)

6. Scholarships — IRC §117

6.1 Tax-free vs taxable scholarship

• Tax-free scholarship rule — Under §117(a), a scholarship or fellowship grant is tax-free to a degree candidate at an eligible educational institution to the extent used for qualified tuition and related expenses (QTRE): Tuition and fees required for enrollment; Course-related books, supplies, and equipment required of all students in the course. (§117(a))
• Taxable scholarship uses — Amounts used for room, board, travel, optional fees, or other personal expenses are taxable wages-equivalent income, reported on Form 1040 Line 8r (or Line 1a if it appears on a W-2) and subject to ordinary income tax (but not self-employment tax). Service requirements (teaching, research) generally render the grant taxable under §117(c), with narrow exceptions for NHSC and Armed Forces scholarship programs. (§117(c))

6.2 Election to make scholarship taxable — planning trick

• Recharacterization election — A scholarship designated by the donor (or by the institution) for tuition only must reduce QTRE for AOTC. But if the scholarship is unrestricted (i.e., the student may apply it to room and board), the family may elect to allocate the scholarship to room and board and treat that portion as taxable income to the student. This frees up tuition expenses to claim AOTC. (unsure - no citation provided)
• Conditions for this to work — This works when: The scholarship terms permit application to non-tuition expenses (verify in the award letter — if restricted, the planning is unavailable). The student's other income plus the recharacterized scholarship is below the standard deduction ($15,750 single in 2025), so the student pays no actual tax on the 'taxable' scholarship. The kiddie tax rules do not push the scholarship into the parent's bracket. Scholarships included in income under §117(c) are treated as earned income for purposes of the kiddie-tax standard-deduction calculation under §63(c)(5), per Rev. Rul. 2005-46 and Notice 87-31 — so the student's standard deduction is the full $15,000 (2025), not the $1,300 unearned-income floor. (§63(c)(5); Rev. Rul. 2005-46; Notice 87-31)

The credit pickup can be substantial: $2,500 of AOTC vs $0 of student-level tax. Document the analysis carefully — this is a planning position the IRS scrutinizes but has explicitly endorsed in Pub. 970 ("Coordination with Pell grants and other scholarships").

AUDIT FLASH POINT — scholarship recharacterization. When you elect to make a portion of a scholarship taxable to claim AOTC, expect the IRS automated underreporter (CP2000) to flag the mismatch between 1098-T Box 5 (scholarships) and the student's reported income. Document the position with: (1) the award letter showing the scholarship is unrestricted; (2) a workpaper allocating the scholarship to specific non-QTRE expenses; (3) a statement on the return (Pub. 970 method); (4) Form 8863 reconciled to the allocation. Anticipate the CP2000 and have the response ready in the file.

6.3 Pell grants

• Pell grants treatment — Pell grants are treated as scholarships and follow the §117 rules. The same election applies — a family can elect to include a Pell grant in the student's income (to the extent it could have been used for room and board) to free up tuition for AOTC. See Pub. 970 Chapter 1. (Pub. 970 Chapter 1)

6.4 Athletic scholarships

• Athletic scholarship treatment — Tax-free if the student is a degree candidate and no service (teaching, athletic performance contract) is required as a condition of the scholarship. NCAA Division I athletic scholarships are generally tax-free for QTRE purposes despite the participation requirement, under longstanding IRS practice; the NIL income from name/image/likeness deals, by contrast, is fully taxable as ordinary income (and is self-employment income if the student is in the trade or business of NIL — emerging issue, refer to specialist). (unsure - no citation provided)

6.5 Work-study

• Work-study wage treatment — Federal work-study earnings are W-2 wages, fully taxable as ordinary income, subject to FICA (unless the student-FICA exception under §3121(b)(10) applies — typically while enrolled half-time+). Not eligible for §117 exclusion. (§3121(b)(10))

7. Employer-Provided Educational Assistance — IRC §127

7.1 Headline numbers (2025)

§127 headline numbers 2025 (IRC §127; P.L. 119-21 §70412)

Item	Value	Source
Maximum tax-free per employee per year	$5,250 for 2025; indexed after 2026	§127(a)(2); P.L. 119-21 §70412
Plan document required	Yes — written plan; nondiscriminatory	§127(b)
Student loan repayments included	Yes for 2025; permanent for payments after 2025 under P.L. 119-21 §70412	§127(c)(1)(B); CARES §2206; SECURE 2.0 §111; P.L. 119-21 §70412

7.2 What qualifies

• §127 qualifying expenses — Tuition, fees, books, supplies, and equipment for undergraduate or graduate coursework. The education need not be job-related (this is broader than the §132(d) working condition fringe). Courses involving sports, games, or hobbies are excluded unless they relate to the employer's business or are required as part of a degree program. (§132(d))

7.3 Student loan repayments under §127

• §127 student loan repayment exclusion made permanent — The CARES Act added employer payments of principal or interest on an employee's qualified education loans to §127 educational assistance. SECURE 2.0 extended the rule through 2025. P.L. 119-21 §70412 removed the January 1, 2026 sunset for payments made after 2025 and added inflation indexing for the $5,250 annual cap for taxable years beginning after 2026. (P.L. 116-136 §2206; P.L. 117-328 §111; P.L. 119-21 §70412)
• Combined cap — The $5,250 cap is combined across direct tuition payments and loan repayments. An employer cannot pay $5,250 of tuition and $5,250 of loan repayments tax-free in the same year. For taxable years beginning after 2026, P.L. 119-21 §70412 indexes the cap for inflation, rounded to the nearest $50. (IRC §127(a)(2), (d); P.L. 119-21 §70412)

7.4 Interaction with §221

• No double-dip with §221 — Loan repayments excluded under §127 are not also deductible by the employee under §221. The employee cannot double-dip: if the employer's $5,250 payment included $1,500 of interest, that $1,500 is not §221-deductible by the employee. (IRC §127(c)(1)(B); IRC §221(d)(2))

7.5 Interaction with §117(d) qualified tuition reduction

• Stacking with §117(d) — For employees of educational institutions, §117(d) provides a separate exclusion for qualified tuition reductions (graduate-level reductions only for teaching/research assistants). §127 and §117(d) can stack in some cases — refer to specialist. (§117(d))

8. §529 Qualified Tuition Programs

OBBBA §70413/§70414 update: for distributions after July 4, 2025, §529 can cover additional elementary/secondary expenses and postsecondary credentialing expenses. The K-12 annual cap remains $10,000 for 2025 and rises to $20,000 for taxable years beginning after December 31, 2025.

8.1 Federal income tax treatment

• 529 QTP federal treatment — Under §529, a Qualified Tuition Program (QTP) is a state-sponsored or private institution-sponsored savings account where contributions are not deductible for federal income tax purposes, earnings grow federal-income-tax-deferred, and qualified distributions are federal-income-tax-free. Qualified uses include higher education expenses, limited elementary/secondary expenses, apprenticeship expenses, student loan repayment up to the statutory lifetime cap, postsecondary credentialing expenses after July 4, 2025, and 529-to-Roth rollovers that meet SECURE 2.0 conditions. Non-qualified distributions are taxable on the earnings portion, plus a 10% additional tax under §529(c)(6), subject to exceptions. (IRC §529; P.L. 119-21 §70413, §70414)

8.2 Qualified higher education expenses (QHEE) — §529(e)(3)

• QHEE list — For §529 postsecondary use, qualified higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment; room and board for students enrolled at least half-time, limited to the school's cost-of-attendance allowance or actual institutional housing charge; computers, peripherals, software, and internet access used primarily by the beneficiary during enrollment; special-needs services; and, for distributions after July 4, 2025, qualified postsecondary credentialing expenses under §529(f). (IRC §529(e)(3), (f); P.L. 119-21 §70414)

8.3 K-12 tuition expansion — §529(c)(7)

• K-12 tuition expansion — Beginning in 2018, §529 distributions for K-12 tuition at elementary or secondary public, private, or religious schools are qualified up to $10,000 per beneficiary per year. P.L. 119-21 §70413 expands K-12 qualified expenses for distributions after July 4, 2025 to include curriculum, books and instructional materials, online educational materials, qualifying tutoring/classes outside the home, standardized/AP/college-admission exam fees, dual-enrollment fees, and licensed/accredited educational therapies for students with disabilities. The annual K-12 cap remains $10,000 for 2025 and rises to $20,000 for taxable years beginning after December 31, 2025. Verify state conformity separately. (IRC §529(c)(7); P.L. 115-97 §11032; P.L. 119-21 §70413)

8.4 Apprenticeship programs — §529(c)(8)

• Apprenticeship program distributions — Effective for distributions after 2018 (SECURE Act P.L. 116-94 §302), §529 distributions for fees, books, supplies, and equipment required for participation in an apprenticeship program registered under the National Apprenticeship Act are qualified. No dollar cap. (§529(c)(8); P.L. 116-94 §302)

8.5 Student loan repayments — §529(c)(9)

• 529 student loan repayment cap — Effective for distributions after 2018 (SECURE Act §302), §529 distributions used to make qualified student loan repayments are qualified, subject to a $10,000 lifetime limit per individual (the beneficiary, or a sibling of the beneficiary — separate $10,000 limits). Both principal and interest qualify. Interest repaid with a tax-free 529 distribution is not also §221-deductible (anti-double-dip rule under §221(d)(2)). (§529(c)(9); §221(d)(2))

8.6 529-to-Roth IRA rollover — §529(c)(6)(C), SECURE 2.0 §126

Beginning January 1, 2024, under SECURE 2.0 Act (P.L. 117-328, Div. T §126), unused §529 funds may be rolled over to a Roth IRA for the same beneficiary, subject to all of the following:

529-to-Roth rollover conditions (P.L. 117-328, Div. T §126)

Condition	Requirement	Source
529 account age	At least 15 years old	§529(c)(6)(C)(ii)(II)
Lifetime cap	$35,000 per beneficiary	§529(c)(6)(C)(i)
Annual cap	Counted against beneficiary's IRA contribution limit ($7,000 / $8,000 if 50+ for 2025)	§529(c)(6)(C)(ii)(III)
Beneficiary earned income	Required up to the contribution amount	§219(b) by cross-reference
Contributions in last 5 years	Excluded from rollover-eligible amount	§529(c)(6)(C)(ii)(IV)
Direct trustee-to-trustee	Required	§529(c)(6)(C)(i)
MAGI Roth phaseout	Does not apply to these rollovers	§408A(c)(3), Notice TBD — IRS guidance pending

Open guidance questions (as of November 2025): Whether changing the beneficiary "restarts" the 15-year clock. Conservative position: yes, treat as restart. IRS has not issued formal guidance; await regulations. Whether the rollover counts as a "contribution" for purposes of the Saver's Credit. Conservative position: no.

This is a powerful but slow-build feature — at $7,000/year, draining $35,000 takes five years. Useful for: (a) over-funded 529s where the beneficiary's education was cheaper than projected (scholarship, in-state vs out-of-state, accelerated degree); (b) families using the 529 as a back-door Roth funding vehicle for the beneficiary.

8.7 Front-loading via 5-year gift election — §529(c)(2)(B)

• 5-year gift election — A contributor may elect to treat a §529 contribution as having been made ratably over 5 years for gift tax purposes. For 2025, with the annual gift exclusion at $19,000, a single donor may contribute up to $95,000 per beneficiary ($19,000 × 5) in one year without using lifetime gift exclusion or filing a gift tax return for amounts within the election. A married couple electing gift-splitting can contribute $190,000 per beneficiary. (§529(c)(2)(B))
• Election mechanics and death during period — The election is made on Form 709 in the year of contribution. If the contributor dies during the 5-year period, the unused portion is added back to the gross estate. (unsure - no citation provided)
• 2026 annual exclusion projection — $19,000 (projected, no change) for 2026 (Rev. Proc. 2024-40)

8.8 Coordination with AOTC/LLC

• No double-dip 529 and AOTC/LLC — The same expense cannot generate both a tax-free 529 distribution and an AOTC/LLC credit (anti-double-dip under §25A(g)(2)). The family must: 1. Identify QEE for AOTC ($4,000 maximum to capture full credit). 2. Identify QEE for LLC ($10,000 maximum to capture full credit). 3. Allocate 529 distributions to expenses not used for AOTC/LLC (typically room and board, which is QHEE for 529 but not for AOTC/LLC). 4. If 529 distributions exceed the non-AOTC/LLC qualified expenses, the excess earnings portion is taxable. (§25A(g)(2))

Optimal stacking for a typical undergraduate family with $30,000 total qualified expenses: Reserve $4,000 of tuition for AOTC. Use 529 to pay $26,000 of remaining tuition + room and board. Result: $2,500 AOTC + tax-free 529 earnings on $26,000. If the 529 already paid all $30,000 of expenses, retroactive planning is hard. Some families withdraw $4,000 from the 529 and pay tax + 10% penalty on the earnings portion of that $4,000 to free up the AOTC — usually a losing trade unless earnings portion is small. Run the math.

8.9 Beneficiary changes

• Beneficiary change without tax consequence — The beneficiary of a §529 may be changed to a "member of the family" (§529(e)(2)) of the original beneficiary without tax consequence: spouse, child, sibling, parent, niece/nephew, aunt/uncle, in-laws, first cousin (added in EGTRRA 2001). Useful when one child does not need the full balance — redirect to a younger sibling, a cousin, or even back to a parent or grandparent. (§529(e)(2))

9. Coverdell Education Savings Account — IRC §530

9.1 Headline numbers (2025)

Coverdell headline numbers 2025 (§530)

Item	Value	Source
Annual contribution limit per beneficiary	$2,000 (all contributors combined)	§530(b)(1)(A)(iii)
Beneficiary age limit	Under 18 at contribution; must distribute by 30	§530(b)(1)(E)
MAGI phaseout (contributor) — single	$95,000 to $110,000	§530(c)(1) — not indexed
MAGI phaseout (contributor) — MFJ	$190,000 to $220,000	§530(c)(1) — not indexed
Qualified expenses	Post-secondary AND K-12	§530(b)(2)

9.2 When to use Coverdell vs 529

• History and comparison — Coverdell ESAs were created in 1997 (Taxpayer Relief Act §213) as the original education savings vehicle. They have largely been eclipsed by §529 plans because: 529s have no annual contribution cap; Coverdell caps at $2,000. 529 K-12 use was added in 2018; Coverdell had K-12 from inception. 529 has no age limit; Coverdell must distribute by age 30. 529 has no income phaseout for contributors; Coverdell phases out at modest income. (Taxpayer Relief Act of 1997 §213)

A Coverdell may still make sense for: Self-directed investment choice (529s limit investments to plan-offered portfolios; Coverdells can hold individual securities at most custodians). Lower-income contributors saving for K-12 + post-secondary with very small annual amounts. Estate-planning rollovers from one beneficiary to another family member under 30.

• Rollovers between Coverdell and 529 — Rollovers between Coverdell and 529 are permitted under §530(d)(5) and §529(c)(3)(D) within 60 days, treated as qualified distributions. (§530(d)(5); §529(c)(3)(D))

10. Coordination Rules — Summary Matrix

• No double-dip rule — The "no double-dip" rule under §25A(g)(2), §529(c)(3)(B)(v), §530(d)(2)(C), §127(a), and §117 means the same dollar of expense cannot reduce taxable income or generate a credit through two different provisions. Allocate expenses in this order. (§25A(g)(2); §529(c)(3)(B)(v); §530(d)(2)(C); §127(a); §117)

Coordination expense bucket allocation matrix (IRC §25A; §529; §127; §221; Pub. 970; P.L. 119-21 §70412-§70414)

Step	Expense bucket	First-best use
1	$4,000 of tuition + required fees + books (per student, AOTC-eligible)	AOTC
2	Additional tuition + required fees for non-AOTC students up to $10,000 cumulative across return	LLC (if AOTC not claimed for that student)
3	Room and board for half-time+ students; K-12 expenses up to $10k in 2025 / $20k for 2026+; postsecondary credentialing expenses after July 4, 2025	§529 distributions
4	Required fees / tuition paid by employer	§127 ($5,250 cap; indexed after 2026)
5	Scholarships restricted to tuition	Reduce QEE for AOTC/LLC (or elect to recharacterize if unrestricted — see §6.2)
6	Student loan interest	§221 deduction (separate, no expense overlap)

• Order to run the math — When multiple provisions could apply, run the math in this order: 1. Compute AOTC (highest dollar-for-dollar value: refundable + per-student). 2. Compute LLC for non-AOTC-eligible students. 3. Allocate remaining QHEE to 529. 4. Allocate scholarships and §127 to non-credit-eligible expenses if possible. 5. Compute §221 student loan interest deduction independently. (unsure - no citation provided)

11. Form 8863 Walkthrough

11.1 Structure

Form 8863 structure (unsure - no citation provided)

Part	Purpose	Notes
Part I	Refundable AOTC	Lines 1-8; computes 40% refundable portion
Part II	Nonrefundable AOTC + LLC	Lines 9-19; flows to Schedule 3 Line 3
Part III	Per-student information (one Part III per student)	Lines 20-31; reports 1098-T data, eligibility tests

11.2 Per-student Part III key entries

• Line 20: Student name + SSN/ITIN/ATIN
• Line 21: Institution name + address + EIN (from 1098-T Box 7)
• Line 22a: Whether 1098-T was received (must be Yes to claim AOTC unless institution not required to issue)
• Line 23: Felony drug conviction question (must be No for AOTC)
• Line 24: Half-time enrollment question (must be Yes for AOTC)
• Line 25: AOTC claimed in prior 4 years (must be < 4 prior claims for AOTC)
• Line 26: Completed first 4 years of post-secondary before 2025 (must be No for AOTC)
• Line 27-30: Qualified expenses (capped at $4,000 for AOTC computation)
• Line 31: LLC qualified expenses (no per-student cap; aggregated at Part II)

11.3 Reconciling 1098-T to actual payments

• 1098-T Box 1 and Box 5 meaning — Form 1098-T Box 1 reports payments received by the institution for QTRE during the calendar year. Box 5 reports scholarships and grants. The credit is based on what was paid for qualified expenses in the calendar year, not what was billed. (unsure - no citation provided)

• Spring 2025 tuition billed in November 2024, paid in December 2024 → reported on 2024 1098-T, claimed on 2024 return. Many institutions bill in December for the following spring term.

• Spring 2025 tuition billed in November 2024, paid in January 2025 → reported on 2025 1098-T (when paid), claimed on 2025 return.

• Books purchased from Amazon (not the institution) → not on 1098-T at all; AOTC-eligible if required for courses.

• Scholarships disbursed before tuition paid → may distort 1098-T netting; reconcile to bursar's statement.

• Refunds for dropped courses → reduce qualified expenses paid in the year of refund.

AUDIT FLASH POINT — missing 1098-T reconciliation. The IRS Pre-Refund Wage and Investment program runs an automated match between Form 8863 expenses and Form 1098-T Box 1. Substantial overage (claimed expenses > 1098-T Box 1 + documented out-of-pocket books) triggers CP2000 letters and EITC-style refund holds. Always reconcile: 1. Total payments per 1098-T Box 1. 2. Plus books and required course materials documented by receipt. 3. Minus scholarships per 1098-T Box 5 (subject to recharacterization election in §6.2). 4. Minus tax-free 529 distributions documented per 1099-Q. 5. Equals claimable expenses, capped at $4,000 (AOTC) or $10,000 (LLC). Attach the reconciliation worksheet to the return file and retain bursar's statements for 3 years (or 6 years if the AOTC is the lion's share of the refund — §6501(e) extended statute applies if 25%+ of credits are at risk).

11.4 Filing red flags to avoid

• Form 8863 with no Part III (refund preparer fraud pattern targeted by IRS).
• Multiple AOTCs for the same student across years 5+ (audit certain).
• Form 8863 without 1098-T and without statement explaining absence.
• AOTC claimed for a student whose only enrollment is summer-only or audit-only courses.
• Filed by a paid preparer with a high AOTC denial rate (IRS issues PTIN-targeted notices to preparers).

12. Worked Examples

12.1 Example A — Family with two undergraduates

Facts. Carlos and Sofia file MFJ. MAGI $145,000. Two children:

• Daniel, age 19, sophomore at State University, full-time, no prior AOTC claims by anyone, no drug conviction, pursuing BA in Computer Science. 2025 expenses: $14,000 tuition, $1,200 required fees, $900 books. No scholarships. No 529 distributions.
• Elena, age 22, senior at Liberal Arts College, full-time, AOTC claimed for her years 1-3 (so 2025 is her 4th eligible year), no drug conviction. 2025 expenses: $32,000 tuition, $2,100 fees, $1,400 books. $8,000 in unrestricted scholarship. No 529.

Analysis.

Daniel. AOTC eligibility: degree-seeking ✓, half-time+ ✓, first 4 years ✓, < 4 prior AOTC ✓, no drug conviction ✓. Qualified expenses = $14,000 + $1,200 + $900 = $16,100. AOTC base capped at $4,000. AOTC = 100% × $2,000 + 25% × $2,000 = $2,500. Phaseout: MFJ $160k-$180k; MAGI $145k is below the floor — no phaseout. Full $2,500.

Elena. AOTC eligibility: degree-seeking ✓, half-time+ ✓, first 4 years ✓ (she has not completed 4 years yet — this is her 4th year), < 4 prior AOTC ✓ (3 prior claims), no drug conviction ✓. Qualified expenses before scholarship reduction = $32,000 + $2,100 + $1,400 = $35,500. Scholarship is unrestricted — consider recharacterization. If we apply the $8,000 scholarship to room and board (recharacterize as taxable to Elena):

• Elena reports $8,000 of taxable scholarship income on her own return (Line 8r). Her other 2025 income: $3,200 from summer internship. Total $11,200. Standard deduction $15,000 (single, treated as earned income per §63(c)(5)). Tax = $0.
• AOTC qualified expenses remain $4,000 capped. AOTC = $2,500.
• If scholarship had been left applied to tuition, QEE for AOTC would still be $35,500 - $8,000 = $27,500, well above $4,000 cap — so AOTC would still be $2,500. The recharacterization does not change Elena's AOTC in this case because QEE is so far above the $4,000 cap. Keep the scholarship applied to tuition; no benefit to recharacterization here. (The recharacterization trick matters only when scholarships push QEE below $4,000.)

Total credit. AOTC = $2,500 × 2 = $5,000. Phaseout: none (MAGI $145k below $160k floor). Refundable portion: 40% × $5,000 = $2,000 (subject to kiddie-tax restriction — does not apply because Carlos and Sofia are claiming the credits on their joint return, not the children's returns). Nonrefundable portion: $3,000.

Form 8863. Two Part IIIs (one each for Daniel and Elena). Part I total credit $5,000, refundable portion $2,000 flows to Form 1040 Line 29. Part II nonrefundable $3,000 flows to Schedule 3 Line 3.

12.2 Example B — Graduate student, LLC only

Facts. Priya, single, MAGI $72,000. PhD candidate in molecular biology at private university, 2nd year of doctorate. 2025 expenses: $18,000 tuition (after $40,000 tuition waiver — the waiver itself is §117(d) qualified tuition reduction, tax-free, separate from AOTC analysis), $1,500 fees, $600 books required by the institution. $25,000 stipend (taxable as compensation for teaching/research duties under §117(c) — reported on W-2 as wages).

Analysis.

AOTC ineligible — beyond first 4 years of post-secondary (PhD). LLC available.

LLC qualified expenses: $18,000 tuition + $1,500 fees = $19,500 (books not required by institution as fee — buy-from-anywhere books are not LLC-qualified). LLC base capped at $10,000. LLC = 20% × $10,000 = $2,000.

Phaseout: single $80k-$90k. MAGI $72k below floor — no phaseout.

LLC = $2,000 nonrefundable. Flows to Schedule 3 Line 3.

Stipend $25,000 is W-2 wages; included on Form 1040 Line 1a. The tuition waiver is excluded under §117(d) and not on the W-2 — verify the W-2 Box 1 excludes it.

Form 8863. No Part I (LLC has no refundable portion). Part III for Priya. Part II Line 10 reports $10,000 LLC qualified expenses; Line 12 LLC = $2,000.

12.3 Example C — 529 + AOTC planning trap

Facts. Theodore, divorced, MAGI $165,000, files HoH. Daughter Maya, age 18, freshman at State Tech. 2025 expenses: $12,000 tuition, $800 fees, $1,200 books, $11,000 room and board on campus. No scholarships. Theodore withdrew $25,000 from his §529 for Maya — used for tuition $12,000, fees $800, room and board $11,000, and books $1,200.

Analysis.

If the 529 distribution is applied as Theodore initially did, every dollar of QEE is offset by tax-free 529 — no AOTC possible (no remaining QEE). This is the classic 529+AOTC trap.

Better allocation: reserve $4,000 of tuition for AOTC, apply 529 only to the remaining $21,000 of qualified expenses:

• AOTC base: $4,000 tuition (paid out of pocket, not from 529).
• 529 distribution: $25,000 used for $8,000 remaining tuition + $800 fees + $11,000 room and board + $1,200 books + $4,000 ... wait, that's $25,000 only if room and board is fully covered. Need to recalculate: total qualified expenses (including room and board) = $12,000 + $800 + $1,200 + $11,000 = $25,000. We reserve $4,000 of tuition for AOTC (paid out of pocket). 529 covers the remaining $21,000.
• Problem: Theodore actually withdrew $25,000 from 529. If only $21,000 is qualified-expenses-covered by 529, the excess $4,000 of 529 distribution is non-qualified — earnings portion is taxable + 10% penalty.

Computation of taxable portion of $4,000 excess distribution:

• Assume Theodore's 529 has basis $40,000 and earnings $20,000; total $60,000. Earnings ratio = 20/60 = 33.3%.
• Excess distribution $4,000 × 33.3% = $1,333 taxable earnings.
• $1,333 added to AGI; tax at marginal rate (say 24%) = $320 income tax.
• 10% additional tax = $133.
• Total cost of "freeing up" AOTC = $453.

AOTC benefit:

• Phaseout: HoH same as single, $80k-$90k. MAGI $165k far above ceiling — AOTC fully phased out.
• AOTC = $0.

Conclusion: Theodore cannot use AOTC because of MAGI; the 529+AOTC trap is moot here. The $25,000 should be left as fully 529-covered to maximize tax-free distribution. Document the analysis showing AOTC was considered and rejected for MAGI.

Alternative scenario. Suppose Theodore's MAGI were $70,000 (below phaseout floor). Then:

• AOTC = $2,500 (full).
• 529 non-qualified-portion cost = $453.
• Net benefit = $2,500 − $453 = $2,047. Do the recharacterization.

This worked example shows: always check MAGI phaseout before recommending the 529+AOTC reallocation, and always quantify the cost of generating a non-qualified 529 distribution when planning.

13.1 Primary statutory authority

IRC §25A — Hope and Lifetime Learning Credits (AOTC under §25A(i), LLC under §25A(c))

• IRC §117 — Qualified scholarships (IRC §117)
• IRC §127 — Educational assistance programs (IRC §127)
• IRC §221 — Interest on education loans (IRC §221)
• IRC §529 — Qualified tuition programs (IRC §529)
• IRC §530 — Coverdell education savings accounts (IRC §530)
• IRC §6050S — Information reporting (Form 1098-T, 1098-E) (IRC §6050S)
• IRC §6051 / Treas. Reg. §1.6041 — Form 1099-Q reporting for 529 distributions (IRC §6051 / Treas. Reg. §1.6041)

13.2 Key legislative history

• Tax Cuts and Jobs Act (P.L. 115-97) — §11032 — added K-12 tuition to §529. (Tax Cuts and Jobs Act (P.L. 115-97, Dec. 22, 2017) §11032)
• Consolidated Appropriations Act, 2021 (P.L. 116-260) — §104 — repealed §222 Tuition and Fees Deduction; conformed LLC phaseout to AOTC phaseout. (Consolidated Appropriations Act, 2021 (P.L. 116-260, Dec. 27, 2020) §104)
• CARES Act (P.L. 116-136) — §2206 — added student loan repayment to §127 (originally through 2020). (CARES Act (P.L. 116-136, March 27, 2020) §2206)
• SECURE Act (P.L. 116-94) — §302 — added apprenticeship and $10k lifetime student loan repayment to §529 qualified expenses. (SECURE Act (P.L. 116-94, Dec. 20, 2019) §302)
• SECURE 2.0 Act (P.L. 117-328) — §126 — added $35,000 lifetime 529-to-Roth rollover effective 2024; §111 extended §127 loan repayment through 2025 (later made permanent by P.L. 119-21 §70412). (SECURE 2.0 Act (P.L. 117-328, Div. T, Dec. 29, 2022) §126, §111)
• One Big Beautiful Bill Act (P.L. 119-21) — P.L. 119-21 added education changes relevant to this guide: §70412 made employer student-loan repayment assistance under §127 permanent for payments after 2025 and indexed the $5,250 cap after 2026; §70413 expanded §529 elementary/secondary expenses after July 4, 2025 and raises the annual K-12 cap to $20,000 for taxable years after 2025; §70414 added §529 postsecondary credentialing expenses for distributions after July 4, 2025; §70606 requires SSNs for AOTC/LLC claims for taxable years beginning after 2025. (P.L. 119-21 §70412, §70413, §70414, §70606)

13.3 IRS guidance and forms

Pub. 970 (2024 ed., expected 2025 ed. release Q1 2026) — Tax Benefits for Education

Form 8863 + Instructions (2024 ed.; check for 2025 updates after IRS releases Q4 2025)

Form 1098-T + Instructions

Form 1098-E + Instructions

Form 1099-Q + Instructions

Form 709 — Gift tax return for 529 5-year-front-load election

• Rev. Proc. 2024-40 — 2025 inflation adjustments (for §221 phaseout indexing) (Rev. Proc. 2024-40)
• Rev. Rul. 2005-46 — Scholarship as earned income for §63(c)(5) standard deduction purposes (Rev. Rul. 2005-46)

Same topic

13.4 Pending IRS guidance to watch (as of Nov 2025)

§529(c)(6)(C) 529-to-Roth rollover: regulations clarifying 15-year clock on beneficiary changes, treatment of contributions in last 5 years.

§529 postsecondary credentialing guidance and 2026 Form 8863 SSN implementation details.

AOTC Pre-Refund W&I program: any updated examination procedures published in IRM 4.19.

13.5 Skill metadata

Author: openaccountants.com US Federal Tax Skills Team

Reviewer: pending Circular 230 review (EA/CPA/attorney)

Verification jurisdiction: federal-tax-us

Verified by lead accountant: pending

Next review trigger: (a) Q4 2025 OBBBA technical corrections; (b) IRS release of 2025 Form 8863 instructions; (c) IRS guidance on §529 credentialing and 2026 Form 8863 SSN implementation.

Talk to a verified accountant

This skill is a tool, not an engagement. Every taxpayer's situation is different, and the rules in the skill may not match your specific facts.

To speak with one of the licensed accountants who verifies skills for your jurisdiction — no liability on either side until you and the accountant sign a formal engagement letter — book a free 30-minute call:

→ Book a call

We'll route you to the named verifier covering your country or state. You can also see the full list of verified accountants at openaccountants.com/network.