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Education Tax Credits: How the American Opportunity Credit Works

Education tax credits like the American Opportunity Tax Credit (AOTC) provide valuable tax relief for students and families paying for higher education. These credits directly reduce your tax liability, making them more valuable than deductions which only reduce taxable income.

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit is the more generous of the two education credits available to taxpayers.

Credit Amount and Calculation

The AOTC provides a tax credit of up to $2,500 per eligible student per year, calculated as:

• 100% of the first $2,000 of qualified education expenses, plus
• 25% of the next $2,000 of qualified education expenses For any eligible student with an election in effect for the taxable year, the American Opportunity Tax Credit equals the sum of 100% of qualified tuition and related expenses paid during the taxable year up to $2,000, plus 25% of expenses that exceed $2,000 but don’t exceed $4,000. IRC § 25A(b)

This means you need to spend $4,000 in qualified expenses to get the maximum credit of $2,500. The credit equals 100% of the first $2,000 spent and 25% of the next $2,000, meaning the full $2,500 credit may be available to a taxpayer who pays $4,000 or more in qualified expenses for an eligible student. IRS – Special IRS Web Section Highlights Back to School Tax Breaks; Popular 529 Plans Expanded, New $2,500 College Credit Available

Refundable Portion

Unlike many tax credits, the AOTC is partially refundable:

• 40% of the credit (up to $1,000) is refundable Forty percent of the American opportunity credit is refundable, meaning that even people who owe no tax can get an annual payment of the credit of up to $1,000 for each eligible student. IRS – Special IRS Web Section Highlights Back to School Tax Breaks; Popular 529 Plans Expanded, New $2,500 College Credit Available
• This means you can receive up to $1,000 even if you have no tax liability The AOTC is a tax credit of up to $2,500 of the cost of tuition, fees and course materials paid during the taxable year, with 40% of the credit (up to $1,000) being refundable, meaning you can get it even if you owe no tax. IRS – American Opportunity Tax Credit: Questions and Answers

The refundable portion is not available to students subject to the “kiddie tax” (where a child’s investment income is taxed at the parent’s rate). The refundable portion of the credit is not available to any student whose investment income is taxed at the parent’s rate, commonly referred to as the kiddie tax. IRS – Special IRS Web Section Highlights Back to School Tax Breaks; Popular 529 Plans Expanded, New $2,500 College Credit Available

Income Limitations

The AOTC is subject to income limitations:

• The full credit is available for taxpayers with modified adjusted gross income (MAGI) of $80,000 or less ($160,000 or less for married filing jointly) The full credit is available for taxpayers whose modified adjusted gross income (MAGI) is $80,000 or less (for married couples filing a joint return, the limit is $160,000 or less). IRS – Special IRS Web Section Highlights Back to School Tax Breaks; Popular 529 Plans Expanded, New $2,500 College Credit Available
• The credit phases out for taxpayers with MAGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers) The American Opportunity Tax Credit is reduced (but not below zero) by the amount which bears the same ratio to the credit as the excess of the taxpayer’s modified adjusted gross income over $80,000 ($160,000 for joint returns) bears to $10,000 ($20,000 for joint returns). IRC § 25A(d)
• The credit is completely eliminated for taxpayers with MAGI above $90,000 ($180,000 for joint filers)

Eligibility Requirements

To qualify for the AOTC, the student must:

• Be pursuing a degree or other recognized education credential To be eligible for AOTC, the student must be pursuing a degree or other recognized education credential. IRS – What you need to know about AOTC and LLC
• Be enrolled at least half-time for at least one academic period during the tax year To be eligible for AOTC, the student must be enrolled at least half-time for at least one academic period beginning in the tax year. IRS – What you need to know about AOTC and LLC
• Not have completed the first four years of higher education at the beginning of the tax year The American Opportunity Tax Credit is for qualified education expenses paid for an eligible student for the first four years of higher education. To be eligible, the student must not have finished the first four years of higher education at the beginning of the tax year. IRS – What you need to know about AOTC and LLC IRS – What you need to know about AOTC and LLC
• Not have claimed the AOTC or the former Hope credit for more than four tax years An election to claim the American Opportunity Tax Credit for any eligible student may not be made for any taxable year if such an election has been in effect for that student for any four prior taxable years. IRC § 25A(b) To be eligible for AOTC, the student must not have claimed the AOTC or the former Hope credit for more than four tax years. IRS – What you need to know about AOTC and LLC
• Not have a felony drug conviction at the end of the tax year To be eligible for AOTC, the student must not have a felony drug conviction at the end of the tax year. IRS – What you need to know about AOTC and LLC

Qualified Expenses

The AOTC covers:

• Tuition and required fees for enrollment or attendance at an eligible educational institution The term “qualified tuition and related expenses” means tuition and fees required for the enrollment or attendance of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer at an eligible educational institution. IRC § 25A(f)
• Course materials (books, supplies, and equipment) For purposes of determining the American Opportunity Tax Credit, “qualified tuition and related expenses” includes “tuition, fees, and course materials” rather than just “tuition and fees.” IRC § 25A(f) Unlike other education tax credits, the American opportunity tax credit includes expenses for course-related books, supplies and equipment that are not necessarily paid to the educational institution. IRS – American Opportunity Tax Credit: Questions and Answers

Expenses that do NOT qualify include:

• Room and board Room and board do not qualify as expenses for the education tax credit. IRS – American Opportunity Tax Credit: Questions and Answers
• Transportation Transportation does not qualify as an expense for the education tax credit. IRS – American Opportunity Tax Credit: Questions and Answers
• Insurance Insurance does not qualify as an expense for the education tax credit. IRS – American Opportunity Tax Credit: Questions and Answers
• Medical expenses Medical expenses do not qualify as expenses for the education tax credit. IRS – American Opportunity Tax Credit: Questions and Answers
• Student activity fees, athletic fees, or other fees not required for enrollment The term “qualified tuition and related expenses” does not include student activity fees, athletic fees, insurance expenses, or other expenses unrelated to an individual’s academic course of instruction. IRC § 25A(f) Student fees are not considered qualified expenses unless they are required as a condition of enrollment or attendance. IRS – American Opportunity Tax Credit: Questions and Answers
• Expenses for sports, games, or hobbies unless part of a degree program The term “qualified tuition and related expenses” does not include expenses for any course or other education involving sports, games, or hobbies, unless such course or other education is part of the individual’s degree program. IRC § 25A(f)

Coordination with Other Education Benefits

You cannot claim multiple education benefits for the same expenses:

• If you use funds from a 529 plan or Coverdell Education Savings Account to pay for expenses, you cannot also claim those same expenses for the AOTC The total amount of qualified higher education expenses with respect to an individual for the taxable year shall be reduced as provided in section 25A(g)(2) and by the amount of expenses which were taken into account in determining the credit allowed under section 25A. IRC § 529(c)
• You must reduce your qualified education expenses by any tax-free educational assistance The American Opportunity or Lifetime Learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, if the same expenses are not used for both benefits. This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American Opportunity or Lifetime Learning credit. IRS IRM 21.6.5 Individual Retirement Arrangements (IRA), Coverdell Education Savings Accounts (ESA), Archer Medical Savings Accounts (MSA) and Health Savings Accounts (HSA)
• You cannot claim both the AOTC and the Lifetime Learning Credit for the same student in the same year In the case of an individual, there shall be allowed as a credit against the tax imposed for the taxable year the amount equal to the sum of the American Opportunity Tax Credit, plus the Lifetime Learning Credit. IRC § 25A(a)

Lifetime Learning Credit (LLC)

The Lifetime Learning Credit is an alternative to the AOTC with different eligibility requirements:

Key Differences from AOTC

• Credit amount: Up to $2,000 per tax return (not per student) The lifetime learning credit is worth a maximum benefit of up to $2,000 per tax return, per year, no matter how many students qualify. IRS – College students should study up on these two tax credits
• Available for unlimited years of postsecondary education The lifetime learning credit is available for all years of postsecondary education and for courses to acquire or improve job skills. IRS – College students should study up on these two tax credits
• Available for non-degree courses to acquire or improve job skills The lifetime learning credit is available for courses to acquire or improve job skills. IRS – College students should study up on these two tax credits
• No half-time enrollment requirement
• No requirement to be pursuing a degree
• Not refundable The Lifetime Learning Credit is a non-refundable credit limited to the amount of tax liability. IRS IRM 4.19.15 Discretionary Programs

How to Claim Education Credits

To claim either the AOTC or LLC:

• Complete Form 8863, Education Credits To claim either credit, taxpayers must complete Form 8863, Education Credits, and file it with their tax return. IRS – College students should study up on these two tax credits
• Attach it to your Form 1040 or 1040-SR
• Include the required information for each eligible student

Documentation and Recordkeeping

Keep records of:

• Tuition statements (Form 1098-T) from your educational institution
• Receipts for qualified course materials
• Documentation of other qualified expenses
• Records of any scholarships, grants, or tax-free educational assistance received

Conclusion

The American Opportunity Tax Credit offers significant tax benefits for eligible students in their first four years of higher education, providing up to $2,500 per student with up to $1,000 being refundable. For students beyond their fourth year or those taking courses to improve job skills, the Lifetime Learning Credit may be available instead.

When planning for education expenses, consider how these credits can help reduce your overall tax burden, and be sure to coordinate with other education benefits to maximize your tax advantages.

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