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The American Opportunity Credit – Easing the Pain of Higher Education Expense
Written by: Andrea Shrive, MBA
The American Opportunity Credit – Easing the Pain of Higher Education Expense
Sending a child off to college, or returning to school oneself, can be challenging financially. Fortunately, at tax time there’s some relief from the financial pain. For taxpayers below certain income levels, the American Opportunity Tax Credit can provide significant tax savings.
The American Opportunity Tax Credit, or AOTC, is the most generous, and thus most desirable of several education deductions and credits. As a credit, it reduces not the taxable income, but rather the tax itself. It’s worth up to $2,500 and 40% of it is refundable – that’s as much as $1,000 that can be received as a refund even if the taxpayer’s taxable income is zero.
To qualify for the AOTC, the taxpayer, spouse or a dependent must be pursuing a degree or other recognized education credential by attending classes at least half time for at least one academic period during the year at an eligible education institution. The student must not have finished their first four years of higher education at the beginning of the tax year, they must not have claimed the AOTC or the former Hope Credit for more than four tax years, and they must not have a felony drug conviction at the end of the tax year. Furthermore, for the full benefit, the tax return on which the AOTC is claimed must show MAGI (Modified Adjusted Gross Income) of less than $80,000 ($160,000 for joint filers), but there is a phase-out with partial credit up to MAGI of $90,000 ($180,000 for joint filers).
The AOTC is calculated on qualified expenses up to $4,000 paid on the student’s behalf. The most significant qualified expenses are tuition, fees required for enrollment or attendance, books and any supplies and equipment required for the courses of study. Typical education expenses that do not qualify are room and board, transportation, insurance, medical expenses and optional student fees. Additionally, any qualified education expenses paid by tax-free scholarships or with tax-free funds, like distributions from a 529 College Savings plan, do not qualify for the AOTC. Please note that expenses paid using credit cards or student loan proceeds are still qualified expenses.
Because the AOTC is such a generous credit, the IRS examines claims closely. It will be necessary to gather several pieces of documentation to determine eligibility and to calculate the credit. First, the student should receive a Form 1098-T, which shows a variety of information for determining eligibility. Unfortunately, not all the expenses shown on the 1098-T are qualified expenses, so taxpayers or students should contact the Bursar’s office at their school and request a detailed statement showing itemized expenses as well as applied payments. Receipts for any books or other supplies should be kept in case the IRS requests additional support.
Taxpayers whose MAGI is above the threshold should consider whether it would be beneficial to allow their dependent to claim the AOTC on their own return. Neither the parents nor the child would be able to claim the child’s exemption and none of the AOTC would be refundable, but under certain circumstances, losing the child’s exemption will not adversely affect the parents return, while it may yield a benefit on the child’s return.
Keep in mind, the AOTC can be claimed for only four tax years. Since school years cover parts of five calendar years, consider carefully which years to claim the AOTC. If a student goes directly to graduate school after the final term in undergrad, qualified expenses from that entire year can be used to calculate the AOTC and it would be a shame to have wasted the credit on a partial year at the beginning of the student’s education. On the other hand, if the parents have MAGI near the threshold and it’s expected to increase over the next few years, it may be most beneficial to claim the AOTC in that first partial year.
There are many considerations associated with claiming the American Opportunity Tax Credit, but with post-secondary education costs at an all-time high, many taxpayers will find it well worth their while to take the necessary steps. We will be happy to help with any questions you may have.