But the news regarding taxes isn’t all bad. In fact, when you have students in college, the American Opportunity Credit can give you money back and directly reduce how much you owe. In fact, it can mean a much bigger tax refund – which everyone would look forward to!
Here’s what you need to know about this credit and how it can save you money.
What is the American Opportunity Tax Credit?
The American Opportunity Tax Credit (AOTC) is designed to help students and their families pay for college costs. It is not a deduction that lowers the amount of your income subject to taxes. It’s actually a credit that reduces your amount owed (before your tax withholdings are applied) by up to $2,500.
If you don’t owe, or the credit reduces the amount you owe to $0, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.
One of the parents in our Facebook Group Paying for College 101 explained it this way:
A tax credit being “refundable” or “not refundable” has nothing to do with your withholdings. It has to do with whether or not you can reduce your tax liability beyond zero. Let’s say your tax liability is $2,000. If you had $4,000 withheld, you get a $2,000 refund. If you had $2,000 withheld, you get no refund but you don’t owe anything. If you had $0 withheld, you would owe $2,000 when you file your return.
Then let’s say you got $1,000 in education credits. This reduces your tax liability to $1,000. In the same example above, if you withheld $4,000, you would get a $3,000 refund. If you had $2,000 withheld, you would get a $1,000 refund. If you had nothing withheld, you would owe $1,000 when you filed your return.
Where the refundable/non-refundable part comes in is if your credits exceed the amount of your tax liability. $1,000 of each AOTC is refundable, meaning you can get it back even if you don’t have any tax liability. The other $1,500 is non-refundable, meaning it can only be used to reduce your tax liability to zero
If you are able to apply the entire $2,500 to your tax liability, that’s $2,500 of your tax withholding that you will get back!
Who’s Eligible for the Tax Credit?
The student with eligible expenses can claim the credit as long as they are not a dependent on someone else’s tax return. If your student is a dependent on your tax return, you can take the credit on your own taxes.
In order for your student to be eligible for the AOTC, they must:
- Be pursuing a degree or other recognized education credential
- Be enrolled at least half time for at least one academic period beginning in the tax year
- Not have finished the first four years of higher education at the beginning of the tax year
- Not have claimed the AOTC or the former Hope credit for more than four tax years
- Not have a felony drug conviction at the end of the tax year
In addition, the modified adjusted gross income (MAGI) has to be below certain limits to claim the full credit. You may be eligible for the entire amount if your MAGI is below $80,000 for single or $160,000 for married filing jointly.
You can get a reduced credit if your MAGI is between $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly.) Above that, you are not eligible for the American Opportunity Tax Credit.
What Expenses Qualify for the American Opportunity Tax Credit?
The credit is intended to offset qualified educational expenses. This includes tuition, fees, and books. However, payments for room and board, insurance, living expenses, or transportation do not qualify.
Keep in mind that you cannot claim a tax credit for expenses that were paid from a tax-advantaged account, like a 529 plan. To maximize your benefit, use those dollars for the non-qualified expenses so you can claim the full AOTC for tuition, fees, and books.
Claiming the American Opportunity Tax Credit
The great news about this tax credit is that you can claim it for every child you have in college.
To claim the tax credit, you’ll want to look for the college or university to send your student an IRS Form 1098-T. If you don’t receive it in the mail, contact the school to find out where you can get the information. They may have a place it’s stored online and you can print it.
With the information on the school’s form, you’ll add an IRS Form 8863 to your normal tax return in order to claim the credit. The 8863 walks you through determining qualifying expenses and determining the refundable amount.
The IRS explains the allowable credit as, “100 percent of the first $2,000 of qualified education expenses you paid for each eligible student and 25 percent of the next $2,000 of qualified education expenses you paid for that student.”
Form 8863 is also used to determine if you qualify for other education credits, like the Lifetime Learning credit, so don’t skip any of the information! It’s all helpful.
Making College More Affordable
Saving $2,500 on your taxes each year may seem like a drop in the bucket when it comes to college costs, but it’s still money in your pocket. It’s worth going through these steps to get the credit you deserve!
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Use R2C Insights to help find merit aid and schools that fit the criteria most important to your student. You’ll not only save precious time, but your student will avoid the heartache of applying to schools they aren’t likely to get into or can’t afford to attend.
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