Calculating Your American Opportunity Tax Credit

The American Opportunity Tax Credit can provide some relief to the cost of college by providing taxpayers with a credit up to $2,500 per year per qualifying student. Proceeds from the credit can go towards tuition, enrollment fees, and course materials, etc. Only one education credit is allowed per student per year, and the person claiming the credit must be the one who's claiming the student (e.g., parent or self).

The income limit to receive the American Opportunity Tax Credit is $180,000 when filing jointly or $90,000 if you are single, head of household, or a qualifying widow(er). The credit begins to phase out for those making between $80,000 and $90,000 or between $160,000 and $180,000 when married filing jointly. The credit is completely unavailable to taxpayers whose modified adjusted gross income exceeds $90,000 ($180,000 for joint filers).

The credit is only available for the first four years of post-secondary education. To be eligible, the student must be pursuing a program that leads to a degree or some other recognized education credential, and he or she must be enrolled at least half-time for at least one academic period during the taxed year. An academic period can be semesters, trimesters, quarters, or any other period of study, such as a summer school session. Courses can be online. Also, the student must not have been convicted of a felony drug offense by the end of the tax year.

The credit is partially refundable. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.

You may only claim the credit to pay for "qualified education expenses," which include tuition paid to any accredited public, nonprofit, or privately owned college, university, vocational school, or other post-secondary educational institution. Qualified education expenses also include fees and materials that are required for a course, such as books, supplies, and equipment. For the institution to be eligible, it needs to participate in a student aid program with the U.S. Department of Education.

How to Calculate it

The credit itself is calculated as the sum of, 100% of the first $2,000 of qualified education expenses paid for the eligible student plus an additional 25% of the next $2,000 (25% of $2,000 = $500) for a total maximum claim of $2,500 per student per year. Anyone who falls within the income guidelines and is paying $4,000 or more in educational expenses per year will be eligible for the full $2,500.

If you have less than $4,000 in qualifying educational expenses your credit will be less than this. For example if you pay $3,000 in qualifying educational expenses, you would get to claim 100% of that first $2,000—so, $2,000. Then, you'd get to claim 25% of the remaining amount. Twenty-five percent of $1,000 is $250. Add that to the $2,000 and you can see that this individual will receive $2,250 for their tax credit.

There are, however, things that need to be removed from the total amount of education expenses prior to calculating the credit—namely, the tax-free portion of education scholarships, fellowships, federal Pell grants, employer-provided education assistance, veterans' educational assistance, or any other tax-free educational assistance, not including gifts and inheritances.

Qualified education expenses do not include costs for room and board, transportation, or medical insurance. The IRS does not require you to reduce qualified expenses by any amount you pay with borrowed funds, such as student loans or credit cards.

The American Opportunity Tax Credit offers a great benefit for students and those with students as dependents.

Claiming the Credit

To claim the American Opportunity Tax Credit, you must complete Form 8863 and attach the completed form to your tax return. To be eligible, the law requires the student to have received Form 1098-T, Tuition Statement, from an eligible educational institution. Generally, students receive the form from their school by January 31.

Both the taxpayer and the student must have valid taxpayer identification numbers (TIN) issued or applied for on or before the return's due date (including extensions). You may not claim the credit on a later original return or amended return if the TIN is issued or applied for after the return's due date.

If your credit claim was disallowed in a previous tax year, you may need to file Form 8862 before claiming the credit in future tax years. Keep copies of all documents you used to determine eligibility and the credit amount. If the IRS audits your return and finds your claim incorrect without proper documentation, you must pay back the credit amount with interest, may face accuracy or fraud penalties, and can be banned from claiming the credit for 2 to 10 years. More information can be found on the IRS website, here.

Q&A: How does a tax credit affect my tax return?

A tax credit offers taxpayers a method to lower their tax bill or boost their tax refund each year. It directly decreases the tax burden on a dollar-for-dollar basis. This is in contrast to a deduction, which reduces the amount of taxable income.

For example: if you receive a $1,000 tax deduction, it reduces your income by that amount. You then pay your tax rate on a reduced amount of income. If, however, you receive a $1,000 tax credit and have a bill of $3,000, then your tax burden drops to $2,000, saving you more compared to the deduction.

Both credits and deductions are an important component of lowering your federal tax burden each year.