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Coordination with Pell grants and other scholar- ships. You may be able to increase your lifetime learning credit when the student (you, your spouse, or your de- pendent) includes certain scholarships or fellowship grants in the student’s gross income. Your credit may in- crease only if the amount of the student's qualified educa- tion expenses minus the total amount of scholarships and fellowship grants is less than $10,000. If this situation ap- plies, consider including some or all of the scholarship or fellowship grant in the student's income in order to treat the included amount as paying nonqualified expenses in- stead of qualified education expenses. Nonqualified ex- penses are expenses such as room and board that aren't qualified education expenses such as tuition and related fees. Scholarships and fellowship grants that the student in- cludes in income don't reduce the student's qualified edu- cation expenses available to figure your lifetime learning credit. Thus, including enough of the scholarship or fellow- ship grant in the student's income to report up to $10,000 in qualified education expenses for your lifetime learning credit may increase the credit by enough to increase your tax refund or reduce the amount of tax you owe even con- sidering any increased tax liability from the additional in- come. However, the increase in tax liability as well as the loss of other tax credits may be greater than the additional lifetime learning credit and may cause your tax refund to decrease or the amount of tax you owe to increase. Your specific circumstances will determine what amount, if any, of the scholarship or fellowship grant to include in income to maximize your tax refund or minimize the amount of tax you owe. The scholarship or fellowship grant must be one that may qualify as a tax-free scholarship under the rules dis- cussed in chapter 1. Also, the scholarship or fellowship grant must be one that may (by its terms) be used for non- qualified expenses. Finally, the amount of the scholarship or fellowship grant that is applied to nonqualified expen- ses can't exceed the amount of the student's actual non- qualified expenses that are paid in the tax year. This amount may differ from the student's living expenses esti- mated by the student's school in figuring the official cost of attendance under student aid rules. The fact that the educational institution applies the scholarship or fellowship grant to qualified education ex- penses, such as tuition and related fees, doesn't prevent the student from choosing to apply certain scholarships or fellowship grants to the student's actual nonqualified ex- penses. By making this choice (that is, by including the part of the scholarship or fellowship grant applied to the student's nonqualified expenses in income), the student may increase taxable income and may be required to file a tax return. But this allows payments made in cash, by check, by credit or debit card, or with borrowed funds such as a student loan to be applied to qualified education expenses. Example 1—No scholarship. Judy Green, who is un- married, is taking courses at a public community college to be recertified to teach in public schools. Her adjusted gross income (AGI) and her MAGI, for purposes of the credit, are $27,400. Judy claims the standard deduction of $12,550, resulting in taxable income of $14,850 and a tax liability before credits of $1,586. Judy claims no credits other than the lifetime learning credit. In July 2021, she paid $700 for the summer 2021 semester; in August 2021, she paid $1,900 for the fall 2021 semester; and in Decem- ber 2021, she paid another $1,900 for the spring semester beginning in January 2022. Judy and the college meet all requirements for the lifetime learning credit. She can use all of the $4,500 tuition she paid in 2021 when figuring her 2021 lifetime learning credit. She claims a $900 lifetime learning credit and her tax liability after credits is $686. Example 2—Scholarship excluded from income. The facts are the same as in Example 1—No scholarship, except that Judy was awarded a $1,500 scholarship. Un- der the terms of her scholarship, it may be used to pay any educational expenses, including room and board. If Judy excludes the scholarship from income, she will be deemed (for purposes of figuring her education credit) to have applied the scholarship to pay for tuition, required fees, and course materials. Only $3,000 of the $4,500 tui- tion she paid in 2021 could be used when figuring her 2021 lifetime learning credit. Her lifetime learning credit would be reduced to $600 and her tax liability after credits would be $986. Example 3—Scholarship included in income. The facts are the same as in Example 2—Scholarship exclu- ded from income. If, unlike Example 2, Judy includes the $1,500 scholarship in income, she will be deemed to have applied the entire scholarship to pay for room and board. Judy's AGI and MAGI would increase to $28,900, her tax- able income would be $16,350, and her tax liability before credits would be $1,766. She would be able to use the $4,500 of adjusted qualified education expenses to figure her credit. Judy could claim a $900 lifetime learning credit and her tax liability after credits would be $866. Example 4—Scholarship applied by the postse- condary school to tuition. The facts are the same as in Example 3—Scholarship included in income, except the $1,500 scholarship is paid directly to the public commun- ity college. The fact that the public community college ap- plies the scholarship to Judy's tuition and related fees doesn't prevent Judy from including the $1,500 scholar- ship in income. As in Example 3, by doing so, she will be deemed to have applied the entire scholarship to pay for room and board. Judy could claim the $900 lifetime learn- ing credit and her tax liability after credits would be $866. Note. Whether you will benefit from applying a schol- arship or fellowship grant to nonqualified expenses will depend on the amount of the student's qualified education expenses, the amount of the scholarship or fellowship grant, and whether the scholarship or fellowship grant may (by its terms) be used for nonqualified expenses. Any benefit will also depend on the student's federal and state marginal tax rates as well as any federal and state tax credits the student claims. Before deciding, look at the to- tal amount of your federal and state tax refunds or taxes owed and, if the student is your dependent, the student's Page 28 Chapter 3 Lifetime Learning Credit