Their are two different tax credits available for those who pay tuition for higher education. They are the American opportunity tax credit (valid during 2009 and 2010) and Lifetime learning credit.
The American opportunity tax credit is for the first four years of school. It replaces the Hope credit for 2009 and 2010. The Hope credit is only for the first two years. The full credit of $2500 is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above these levels. These income limits are higher than under the existing Hope and Lifetime Learning Credits. American opportunity tax credit (AOTC) includes expenses for course-related books, supplies and equipment which are not necessarily paid to the educational institution but the Hope credit and the Lifetime learning credit only allows tuition and fees charged by the college, therefore books would not be allowed. The following expenses do not qualify for tax credits: room and board, transportation, insurance, medical expenses, student fees except if they are a condition of enrollment or attendance, expenses paid with non-taxable funds or tax-free educational assistance or the same expenses used for any other tax deduction, credit or educational benefit. Taxpayers will receive a tax credit based on 100 percent of the first $2,000 of tuition, fees and course materials paid during the taxable year, plus 25 percent of the next $2,000 of tuition, fees and course materials paid during the taxable year.
Lifetime learning credit can be used for graduate classes, or when the AOTC expires, during the last two years of undergraduate education. Unlike the Hope Scholarship Credit, the Lifetime Learning Credit is calculated on a per family, rather than a per student, basis. Therefore, the maximum available credit does not vary with the number of students. Either the parent or the child, but not both, may claim the credit for the child's expenses in a particular year. If an individual claims the child as a dependent on his/her Federal income tax return for the year, only the individual may claim the Lifetime Learning Credit for the child's qualified tuition and related expenses. If no one claims the child as a dependent on a Federal income tax return for the year, only the child may claim the Lifetime Learning Credit for the child's expenses. Remember, if you are a dependent your parents must pay the tuition bill to get the tax credit. This means that a scholarship or student loan cannot pay for the tuition, if your parents or you want to take the tax credit. The person getting the tax credit must pay for the tuition. If you are not a dependent then the student loan, but not a scholarship, can pay for the tuition bill. The credit is equal to 20 percent of the taxpayer's out-of-pocket expenses up to a maximum of $10,000 in expenses. Thus, the maximum Lifetime Learning Credit (LLC) a taxpayer may claim is $2,000. The maximum credit does not change even if the taxpayer is claiming a credit for the expenses of more than one student in the family. A way to get around this is to use the AOTC and the LLC together or the LLC and the tuition deduction.
Also, you can use the grants,student loans, scholarships and money from a 529 to pay for the expenses not covered by the credit. For example, if you are taking the LLC, pay for your books plus transportation and living expenses from the student loans, grants etc. but if you were using the AOTC make sure to use your own money for the books and use the grant, 529 etc. on such things as transportation and living expenses.
By being careful and planning, you can minimize the cost of school. This may mean planning where and from who the money comes from but it can be done.