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American Opportunity Tax Credit (AOTC)

A tax credit that allows students or their parents to reduce their college education expenses

What is the American Opportunity Tax Credit (AOTC)?

The American Opportunity Tax Credit (AOTC) is a tax credit that gives students or their parents the opportunity to reduce their college education expenses. It helps pay for qualified expenses for the first four years after completing secondary education.

 

American Opportunity Tax Credit

 

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AOTC provides a relief of up to $2,500 in tax credits on the first $4,000 of qualifying education expenses, and 40% or $1,000 refunds if the student does not owe any taxes, subject to income limitations. The qualifying education expenses comprise materials that are required for tuition and other expenses related to the student’s college enrollment.

 

Eligibility for the American Opportunity Tax Credit

The US Internal Revenue Service provides guidelines on the eligibility of students for the AOTC program. Typically, students must meet the following requirements to be eligible for the tax credit:

  • Be pursuing a degree or other recognized education qualification
  • Have not been convicted of any drug offense at the end of the tax year
  • Must be enrolled at least half of at least one academic period at the beginning of the tax year
  • Be enrolled in a recognized post-secondary institution
  • Have not claimed AOTC during the previous tax years

 

Also, a single taxpayer must have a modified adjusted gross income (MAGI) of not more than $80,000 to qualify for full credit. A single taxpayer with a MAGI of more than $80,000 but less than $90,000 qualifies for partial credit at a reduced rate. Single taxpayers with MAGI exceeding $90,000 are not eligible to claim AOTC.

Married couples filing joint and with MAGI of less than $160,000 qualify for full tax credits while those with MAGI ranging between $160,000 to $180,000 qualify for the partial credit. On the other hand, married couples filing jointly and with an income exceeding $180,000 are not eligible for the tax credit.

 

Qualifying Education Expenses

The IRS requires that the qualifying education experience comprise tuition paid to the school and specific expenses incurred to purchase books, supplies, software, and other materials that are required for the enrollment of a course. For example, a computer science student may be required to purchase a laptop, software, and technology books before enrolling in the course, and these expenses will be included when calculating tax credits.

However, if the software and laptop are not required during enrollment but during the course of the college education, then these expenses are excluded when calculating the American Opportunity Tax Credit.

Another requirement set by the IRS is that the tuition and education expenses should be paid for with student loans to qualify. Tuition and expenses paid for with scholarships and grants do not qualify for tax credits. Other costs that do not qualify for the AOTC include medical expenses, insurance, room, and boarding costs, as well as expenses paid with tax-free education assistance.

 

Calculating the American Opportunity Tax Credit Amount

When calculating AOTC, it is important to understand that only one tax credit is available to each eligible student per tax year. Also, each student cannot claim more than one tax credit per tax year. The AOTC credit is available to eligible students up to 100% for the first $2,000 of qualified tuition and education expenses, and 25% of the expenses that exceed $2,000. The maximum tax credit that a student can claim in AOTC is $2,500.

If a student’s tax liability goes down to zero with AOTC, he/she can receive tax refunds of up to 40% of the remaining credits, up to a maximum of $1,000. Students can use Form 8963 obtained from the IRS to calculate the amount of tax credits that they can claim and attach it to their personal income tax return.

Let’s take the example of two eligible students, A and B. Student A spent $2,500 on tuition and $1,500 on education materials, while student B spent $1,000 on tuition during the previous tax year. It means that student A’s claim with AOTC is (100% x $2,000) + (25% x $2,000) = $2,500. It reduces the tax bill to $1,500 ($4,000-$2,500).

On the other hand, student B’s claim with AOTC can be reduced to zero and still keep leftover credit that can be used to claim a tax refund. The leftover credit is -$1,500 ($1,000-$2,500). It means that student B will get a tax refund of $600 (40% x $1,500).

 

American Opportunity Credit vs. Lifetime Learning Credit

The American Opportunity Credit and the Lifetime Learning Credit (LLC) are two main tax credits that are available to students in the United States. Unlike AOTC that is limited to students pursuing a degree, the LLC is available for any post-secondary education such as graduate school and undergraduate education, including those that exceed four years.

Also, students can claim a maximum of 20% of $10,000 of education expenses. However, when the taxpayer’s tax bill is reduced to zero, he/she will not receive a tax refund as is the case with AOTC.

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Accounting for Income Taxes
  • Ad Valorem Tax
  • How to Use the IRS.gov Website
  • Tax Shield

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