If You're a Student, You May Be Eligible for a $2,500 Tax Credit
By Troy Onink
Contributor to Forbes
Taxpayers who paid qualified college tuition and fee expenses in 2014 may be able to claim the American Opportunity Tax Credit (AOTC) worth up to $2,500 per eligible child. Despite repeated calls for simplifying education tax incentives, frequent legislation submitted in Congress and ongoing confusion between taxpayers and the IRS about how and when to claim the various education tax credits, no one has succeeded in simplifying the mess, yet. The good news? The credit is available through 2017. That means $10,000 of tax savings per child in the next four years. Following are the rules to claim the credit properly, with links to the forms and instructions.
Which College Credit Should You Claim?
There are two college-related tax credits, the American Opportunity Tax Credit and the Lifetime Learning Credit, as well as one deduction, the tuition and fees deduction. You may only claim one credit or the deduction in any given year. The American Opportunity Tax Credit (AOTC) is the logical choice because it is by far the richest at up to $2,500 per eligible child, versus $2,000 and $1,800 for the Lifetime Credit. Think of the AOTC as a better version of the old Hope Credit. The AOTC came about as a result of the infamous “stimulus package” legislation during the financial crises of 2008 to 2009, and essentially took the Hope Credit and made it worth more, and made it available to more families by raising the phase-out levels of income. The American Opportunity Tax Credit was set to expire at the end of 2012, but was extended for five years to 2017 as part of the so-called “fiscal cliff” deal that also extended many of the Bush-era tax credits.
American Opportunity Tax Credit Is Worth The Most
The AOTC is worth up to $2,500 per student for four academic years (remember though that it expires in 2017). The income phase-out is $160,000 – $180,000 of modified adjusted gross income on joint tax returns ($80,000 – $90,000 for single tax filers and head of household). The amount of the credit is calculated as 100% of the first $2,000 in qualified tuition and fees costs paid, plus 25% of the next $2,000 paid for such fees. For lower income taxpayers the credit is refundable up to $1,000, but not for dependent children. College students who are “independent” for tax purposes, meaning that they claim themselves as a dependent on their own tax return (they must provide greater than half of their own support to do so), and provide greater than half of that support from earned income only, are eligible to claim the refundable portion of the AOTC, up to $1,000. For more on the personal exemption and the support test, review IRS Publication 501.
Which College Expenses Count?
You use IRS form 8863 (get the form and instructions here) to claim the American Opportunity Tax Credit, which is based on qualified expenses that you must pay for yourself, your spouse or a dependent for whom you claim an exemption on your tax return.
According to IRS Publication 970 qualified education expenses are tuition and related expenses required for enrollment or attendance at an eligible educational institution.
An eligible educational institution is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, non-profit, and proprietary (privately owned profit-making0 post-secondary institutions.
Related expenses are student-activity fees and expenses for course-related books, supplies, and equipment that are required as a condition of enrollment or attendance. The amount of qualified educational expenses that can be used in calculating these tax credits is reduced if you pay for the qualified expenses with certain tax-free funds:
Tax-free portions of scholarships and fellowships
- Pell grants
- Employer-provided educational assistance (section 127 tuition reimbursement plan)
- Veterans’ educational assistance
- Any other tax-free payments received as educational assistance
Claiming The AOTC Takes Coordination
It is very important to remember that you cannot claim any of the college tax credits, including the AOTC, based on expenses that were used to calculate the tax-free portion of a distribution from a 529 college savings or prepaid plan, or a Coverdell Education Savings Account (ESA). The AOTC may be claimed in the same year that a tax-free distribution is made as long as the same expenses are not used to calculate the tax-free distribution AND the American Opportunity Tax Credit.
For example, if you take $10,000 out of a 529 college savings plan to pay for tuition you cannot also use that $10,000 of tuition expenses to claim the American Opportunity Tax Credit. This coordination of benefits provision is exactly why it helps to have a tax preparer that understands education funding so that you can make the most of the benefits that you qualify for. Even more important, however, is to discuss how you will pay for college ahead of time with a financial planning or tax professional so that you can coordinate ahead of time how to best pay for college using the income and assets that you have, and still be eligible to claim the full amount of college tax credits that you are eligible for.
Make Too Much Money To Qualify For The Credit, Try This?
If you are not able to claim the AOTC because your income exceeds the $180,000 (MAGI) phase-out threshold, maybe your child can claim the credit on his or her tax return. If you cannot, or do not claim the AOTC (or any other tax credit or the tuition and fees deduction), and you also do not claim that child as a personal exemption on your tax return, your child can claim the American Opportunity Tax Credit on his or her tax return. Read this post about an income-shifting College Tax Strategy: How To Wipe Out $25,000 Of Capital Gains In One Year. This strategy is also very effective for minimizing taxes on earned income shifted to a child, too.
The American Opportunity Tax Credit Does Not Impact College Financial Aid
When calculating a student’s expected family contribution (EFC) toward the cost of college, the federal, state and withholding taxes that parents and students pay reduce the amount of their incomes that counts against them in the aid calculation. Since the AOTC reduces the federal income tax paid by parents (or whomever the taxpayer is), and therefore reduces the amount of tax allowances they have against their income in the aid formula, the credit would normally increase the student’s expected family contribution and decrease the student’s aid eligibility. However, the financial aid forms, the FAFSA and the CSS Profile, effectively “add back” the amount of the credit that parents claim on their tax return, thereby eliminating any negative impact on the student’s potential need-based aid eligibility.