Most people know that they should complete the Free Application for Federal Student Aid (FAFSA) each year that their student is in college (see this post for more info).  The FAFSA will be used as the application for federal student loans and to determine your Expected Family Contribution (EFC) – or whether your family will qualify for federal student aid.

But, federal student aid in the form of Pell Grants and various federal student loan programs are not the only ways you have the federal government pitch in on the cost of a college education.  There are tax credits available as well. Here are some details on the first of the credits, the American Opportunity Tax Credit (AOTC). We’ll talk about the Lifetime Learning Credit in a future post.

The AOTC is a tax credit for qualified education expenses that can be worth up to $2,500 per eligible student.  Some important things to note:

This is a tax credit – not a deduction.   A tax credit directly decreases the amount of your tax liability.  A tax deduction only decreases the amount of your taxable income.  

The credit is for 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000 of qualified education expenses – so you need to have $4,000 of qualified education expenses to get the whole credit.

The credit is a refundable credit – meaning if the credit brings your total tax down to zero, 40% of the remaining credit can be refunded to you.

Who is an eligible student?

  • The student must be pursuing a degree or other recognized education credential
  • The student must be enrolled at least half time for at least one academic period during the year
  • The student must not have completed 4 years of higher education at the beginning of the tax year
  • The student must not have claimed the AOTC for more than four tax years
  • The student must not have a felony drug conviction

What is a qualified education expense?

  • Qualified expenses are amounts paid for tuition, fees, books, supplies, and equipment that is required of the student for enrollment or attendance at an eligible school.  
  • Required student activity fees are qualified expenses.
  • Fees or expenses for sports, games and non-credit courses do not qualify unless the course or activity is part of the student’s degree program

What isn’t a qualified education expense?

  • Travel expenses
  • Room and board
  • Insurance
  • Medical expenses – including medical insurance and student health fees
  • Cell phones and cell phone service

There is an income limit to claim this credit. 

It’s also very important to note, there is an income limit to claim this credit.  To claim the full credit, your Modified Adjusted Gross Income (MAGI) must be less than $80,000 if your filing status is single or $160,000 if your filing status is Married Filing Jointly.  The amount of the credit that you can claim phases out so that you cannot claim the credit at all if your MAGI is over $90,000 if you file as Single or $180,000 if you’re Married Filing Jointly.

 There’s no double-dipping on tax advantages.

And, there’s no double-dipping on tax advantages.  In other words, you cannot use dollars from other tax-advantaged sources to qualify for this credit.  That means if you paid $5,000 of qualified expenses from a 529 account and $2,000 from your regular savings or investments, you can only use the $2,000 to calculate the credit.  This is one reason you want to devise a plan for all four years – to avoid possibly losing tax credits by taking too much from the 529 accounts and not paying enough from savings to maximize tax credits.  You can, however, use money from the 529 account to pay room and board and funds from your savings to pay qualified expenses and use those qualified expenses to calculate the tax credit.

Other things to keep in mind:

  • You cannot take the AOTC and the Lifetime Learning Credit in the same year for the same student.
  • You must be claiming the student as a dependent on your tax return.
  • You and the student (and your spouse if you file as Married Filing Jointly) must have a valid taxpayer identification number (usually a social security number) before the due date of the tax return.
  • You cannot claim the AOTC if your filing status is Married Filing Separately or if someone else can claim you on their tax return.
  • See the full details on requirements and limitations on claiming this credit at the AOTC page on the IRS website.

The AOTC is only one of the education tax credits and it can be valuable. It often pays to do some planning – income planning for your or your child, distribution planning for 529s or help from other family members for college expenses, and tax planning – to take advantage of this credit. For more information on other credits, look here.

If you have questions about how this can help you – contact me to set up a time to talk about your specific situation.