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What is the American Opportunity Tax Credit?

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What is the American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a partially refundable tax credit that provides up to $2,500 per student per year to pay for college. The tax credit is based on up to $4,000 in eligible higher education expenses, equal to 100% of the first $2,000 in eligible expenses and 25% of the second $2,000. This tax credit can be taken for up to four years of higher education expenses.

The American Opportunity Tax Credit is claimed per eligible student, not per taxpayer, unlike the Lifetime Learning Tax Credit. So parents can claim the tax credit for more than one child if they have multiple children in college.

The American Opportunity Tax Credit was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (P.L. 114-113) and does not expire.

Who Qualifies for the American Opportunity Tax Credit? 

If you're wondering who qualifies for the American Opportunity Tax Credit, it's a taxpayer who is paying tuition and other related expenses for an eligible student enrolled at least half-time in a program leading to a degree or other recognized education credential. The eligible student must also be in the first four years of post-secondary education and must not have completed the first four years of post-secondary education as of the beginning of the tax year.

In addition, the taxpayer must have a modified adjusted gross income (MAGI) below certain income limits, which the Internal Revenue Service (IRS) set. These income limits are adjusted for inflation. At the time of writing, the taxpayer's MAGI must be $80,000 or less ($160,000 or less for married filing jointly). If your MAGI is more than $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly), you will still receive a reduced credit. 

To learn more, you can visit the IRS website. 

American Opportunity Tax Credit Qualifying Expenses

Qualifying expenses for the AOTC include tuition, fees, and course materials. Course materials include textbooks, supplies, and equipment. Amounts spent on living expenses (room and board, transportation, and health care) are not eligible. Expenses for sports, games, hobbies, and non-credit courses are not eligible unless part of the degree program. Application fees and admissions test fees are also not eligible.

Amount

$2,500 tax credit per student

(100% first $2,000, 25% second $2,000)

40% refundable (up to $1,000)

Eligible Expenses

Tuition, Fees, Course Materials

Eligible Students

Enrolled at least half-time, seeking a degree or certificate, no felony drug convictions

Number of Years

4 years of college, 4 tax years

Income Phase-outs

$160,000 to $180,000 (MFJ)

$80,000 to $90,000 (S)

Coordinating the American Opportunity Tax Credit with Other Tax Benefits

Coordination restrictions prevent double-dipping. You cannot use the same expenses to justify both the American Opportunity Tax Credit and another education tax benefit, such as tax-free scholarships or a tax-free distribution from a 529 college savings plan. Instead, you should use cash or loans to pay for up to $4,000 in tuition and textbook expenses to qualify for the maximum tax credit.

The American Opportunity Tax Credit provides a greater financial benefit per dollar of eligible expenses than any other education tax benefit. Most taxpayers who are eligible for the American Opportunity Tax Credit will be in the 25% tax bracket or lower.

Even considering the 10% tax penalty for non-qualified distributions from a 529 plan, the American Opportunity Tax Credit will be worth more than a tax-free distribution from a 529 plan, since the tax savings from a 529 plan is on the earnings portion of the distribution, while the tax savings from the tax credit is equal to 100% and 25% of the eligible expenses.

If the student receives scholarships that cover all or most of the eligible expenses, the taxpayer could always elect to treat all or part of the scholarship as taxable income to claim the American Opportunity Tax Credit.

American Opportunity Tax Credit's Partial Refundability

The AOTC is partially refundable. After the tax credit is applied to the taxpayer’s tax liability, 40% of any remaining tax credit (up to $1,000) may be refunded to the taxpayer. The tax credit is not refundable if the taxpayer can be claimed it as an exemption on someone else’s income tax return.

The American Opportunity Tax Credit can be claimed by either the student’s parents or the student. If the student is claimed as an exemption on his or her parent’s federal income tax return, expenses paid by the student are treated as though the parent paid them. 

If the student claims the tax credit, the student will not be eligible for partial refundability if he or she can be claimed as an exemption. If the parent’s income is above the phase-outs, it might be worthwhile for the student to claim the tax credit if the student has a tax liability available to offset.

How to Claim the American Opportunity Tax Credit

The American Opportunity Tax Credit is claimed on the taxpayer’s federal income tax return. The taxpayer must complete IRS Form 8863, Education Credits (instructions), and attach it to their federal income tax return to claim the American Opportunity Tax Credit. Taxpayers should use IRS Form 1098-T, Tuition Statement, to complete IRS Form 8863. They should receive this from the college by Jan. 31.

The taxpayer and the student must each have a Social Security Number or Individual Taxpayer Identification Number (ITIN) by the due date of the income tax return to claim the tax credit. Even if the taxpayer and student later get a Social Security Number or ITIN, they cannot retroactively claim the American Opportunity Tax Credit for tax years when either did not have a Social Security Number or ITIN.  

It is important to keep copies of documentation relating to the AOTC. If a taxpayer improperly claims the AOTC, they may be required to repay the AOTC with interest and penalties. They can be banned from claiming the AOTC for two years if the claim involved “a reckless or intentional disregard of the rules” and ten years for fraud.

The American Opportunity Tax Credit- Final Thoughts 

A good source of additional information is Chapter 2 of IRS Publication 970, Tax Benefits for Education. The statutory language appears in the Internal Revenue Code at 26 USC 25A. The regulations can be found at 26 CFR 1.25A-0, 26 CFR 1.25A-1, 26 CFR 1.25A-2, 26 CFR 1.25A-3, 26 CFR 1.25A-4 and 26 CFR 1.25A-5.

U.S. Government Accountability Office Resources on the American Opportunity Tax Credit

The U.S. Government Accountability Office (GAO) has published several reports about the American Opportunity Tax Credit and other education tax benefits. Most of these reports concern the complexity of having multiple overlapping education tax benefits, which causes taxpayers to make suboptimal choices concerning which tax benefits to claim.

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