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 who's 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 widower. Note that the maximum credit is gradually reduced for those making between $80,000 and $90,000 or between $160,000 and $180,000 when married filing jointly.

The credit is only available for the first four years of post-high school 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 have been enrolled at least half of the time during the taxed year. Also, the student must not have been convicted of a felony for possessing or distributing a controlled substance.

You may only claim the credit to pay for “qualified education expenses,” which includes tuition paid to any accredited public, nonprofit, or privately owned college, university, vocational school, or other post-high school educational institution. Qualified education expenses also include enrollment fees or materials that are required for a course. 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, employer-provided education assistance, veterans educational assistance, or any other tax-free educational assistance, not including gifts.

The American Opportunity Tax Credit offers a great rebate for students and those of whom have students as dependents.

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.