What is the American Opportunity Tax Credit?

17 August 2023
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There are significant differences between individual and corporate taxes, but the one commonality is the importance of tax planning. Whether you're dealing with your personal or business taxes, you should plan ahead to minimize your tax liability.


Businesses can reduce their taxable income by claiming deductions for a wide range of business expenses from paperclips to employee reimbursement plans. On top of that, they can directly reduce their tax bill with business-specific credits such as the Employee Retention Credit for businesses that kept employees on payroll during COVID.


Individuals can also save money by claiming deductions and credits, but they are dealing with a significantly different list of options. For most individual taxpayers, the most significant tax savings that they can claim are credits and deductions related to educational expenses. To help you out, this post looks at one of the most valuable education credits — the American Opportunity Tax Credit (AOTC). 

So, what is the American Opportunity Tax Credit? Let's dig into the specifics.


AOTC Eligibility Requirements


To be eligible for the American Opportunity Tax Credit, you must pay qualifying educational expenses for a qualifying student. Students can claim this credit, and it's especially attractive for older non-traditional students who are pursuing a college degree. However, parents can also claim this credit for dependents claimed on their return, and this tends to be the case when you're dealing with younger college students who don't work full time.


Here are the eligibility criteria:


  • The student must be in a degree-based program.
  • The student must not have a four-year degree yet.
  • The student must be enrolled at least half time.
  • The student must not have a felony drug conviction.

 

On top of that, you can only claim the credit four times per student. To give you an example, say that someone's parents claimed this credit four times, but their child never graduated. Several years later, the student goes back to college as an adult — at that point, they cannot claim the credit.


Although they meet all of the other eligibility criteria, the credit has already been claimed four times on their behalf so they are no longer eligible. However, if their parents had only claimed the credit three times, they would be able to claim the credit for one year (as long as they met the other criteria).


Now, say those same parents send another child to college. As long as that child meets the criteria, the parents can claim the credit. The four-year limit applies per student, not per taxpayer. Note that these examples refer to parents, but a spouse or any third-party that pays expenses on behalf of a student can claim this credit.


AOTC Qualifying Expenses

Now that you understand what is the American Opportunity Tax Credit, you're probably wondering which expenses are eligible. Qualifying expenses include tuition, fees, and other related expenses such as student activity fees, books, and supplies.


You can only claim this credit if you receive a 1098-T from the school. This form shows the amount of money that you have paid to the school for tuition, but that is not necessarily the number you will use to calculate the credit.



For example, if you purchased books or supplies from another company, you can add those amounts to your qualifying tuition. Note that this rule is specific to the American Opportunity Tax Credit. You can't necessarily count these expenses when claiming other education credits.

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How to Calculate the American Opportunity Tax Credit


To calculate the American Opportunity Tax Credit, take up to your first $2,000 in qualifying expenses and multiply that by 100%. For instance, if you have $5,000 in qualifying expenses, you multiply the first $2,000 by 100%, meaning that you have a $2,000 credit so far. If you only had $1,600 in qualifying expenses, you multiply that by 100%, giving you a $1,600 credit.


Then, you take the next $2,000 in qualifying expenses and you multiply that by 25%. To continue with the above example, if you had $5,000 in qualifying expenses, you would multiply the next $2,000 by 25%, which is $500. When you add that to your original $2,000 credit, your full credit is $2,500. However, if you only spent $1,600 (or any amount below $2,000), you would skip this step.


Next, you have to consider your tax bill. If you owe more tax than the credit is worth, the full credit will be applied to your tax bill. If you owe less than the credit is worth, you can get up to 40% of the remaining amount as a refund.


How to Claim the American Opportunity Tax Credit


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You'll likely recieve your AOTC form or 1098-T by mail, if not, be sure to stop by your university's student services office for further direction. Once recieve your form, to claim this tax credit, you need to provide your tax preparer with a copy of the 1098-T that you received. Then, you will need to answer a few questions to verify your eligibility for the credit. Finally, you will need to ensure that your income is under the applicable threshold.


You can only receive the full value of the credit if your modified adjusted gross income (MAGI) is $160,000 or less for a couple filing jointly or $80,000 or less for a single filer. If your MAGI is up to $10,000 higher for a single filer or up to $20,000 higher for a joint filer, you can receive a portion of the credit.

The Bottom Line


The bottom line is that if you qualify — this tax credit can put money back into your pocket. Wondering if you meet the criteria? Then, let's talk. We'll look at your situation and help you apply this credit to your return. If you don't qualify, we'll help you explore other options like the Lifetime Learning Credit or the deduction for student loan interest payments.


At Flynn & Company, we are dedicated to helping our clients optimize their tax situations. Whether you're doing tax planning for your family, your business, or both, our accountants can help you analyze the numbers, assess your eligibility for tax credits, and identify the best steps forward. The tax code is very complicated, and if you don't work with an expert, you'll often end up paying more than you should. To get help, contact us today.

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