Even though we’re in uncertain times and we don’t know the specifics as of yet, I think eventually college students are going to go back to school. Now, who knows—it might be in person, it might be online … so what I want to do is talk about one of the most popular college tax credits that’s out there right now, and it’s called the American Opportunity Tax Credit (or the AOTC). This is an annual credit that is up to $2,500 per eligible student.

What makes a student eligible here?

So in order to be eligible, you have to be going to a school that’s a recognized college and pursuing a college degree. You also have to be going at least part-time and this credit can only be taken in the first four years of college. A couple other things that they add is that you cannot have a felony drug conviction, and then you have to meet the income requirement.

Ok, so what are the income limits, then?

If your income is under $80,000 if you file individually or $160,000 if you file as a married couple, you’re probably going to get the credit. Above that amount, there’s phase-outs where you start to lose the credit. And the credit is totally lost if your income is over $90,000 for a single person and $180,000 for a married couple.

So then who gets to claim this credit? There’s a lot of “ifs” and “buts” here.

Normally you would think the child would be able to claim the credit because it’s their tuition, but what really happens is it’s the person that claims them as a dependent on their return. So it could be the parent, the guardian or—if the child claims themselves—it could be the child, also.

You said there’s a maximum credit of $2,500; how is that calculated?

That’s actually a pretty neat calculation. So what it is, is the credit based off of 100 percent of the first $2,000 in tuition paid, and 25 percent of the next $2,000 of tuition paid. So if you have $4,000 worth of tuition paid and you meet the income requirements, you’re probably going to get the full $2,500 credit.

Is it only the tuition that can be used for credit?

  • Tuition
  • Student activity fees
  • Books
  • Supplies
  • Equipment that’s needed for the course of study

Those kinds of things are eligible expenses for this credit, but not room and board, and not the food plan.

Is the credit refundable if you don’t have any tax?

Right. So up to 40 percent of the credit can be refundable. So if you have zero tax and you have a $2,500 credit, $1,500 of that is not going to be able to be used because you have no tax, but $1,000 will get refunded to you.

Does it matter if it’s paid in cash or loans or anything like that?

Doesn’t matter. So you can pay it via cash, you can pay it via loans—that part doesn’t matter. But the thing is, is it does not include things like:

  • Tuition paid via a tax-free scholarship or a grant
  • Any employer reimbursements
  • Veteran’s assistance

Things like that—you know, any time that somebody else is paying it and you’re not physically paying it—those tuition expenses cannot be used for this credit.

And the last thing is something that catches some people. Be very careful when using 529 plans, like Edvest here in Wisconsin, and using those funds to pay for the education expenses, as that may limit the credit.

This is a really big deal, isn’t it?

You know, it really is, and a lot of people kind of fall into this trap. What the IRS says is the use of 529 plan funds to pay educational expenses, those costs cannot then be used for the credit. So you can’t use it for the credit if you’re using 529 plan funds to pay it.

The strategy is—you know, use those 529 plan (those college savings) funds to pay the room and board and the food, and pay cash or take out a loan for the first $4,000 of tuition. Because like we talked about earlier, as long as you have $4,000 in tuition expenses that you pay personally, you can actually take a $2,500 credit. And then anything above that $4,000 for tuition, use the 529 plan funds for that. So just make sure you use $4,000 of your own money at any cost.

 

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Jeff Dvorachek
I joined Hawkins Ash CPAs in 1998. I am the partner-in-charge of the Manitowoc, WI, office and tax director for the firm. I have thorough experience providing tax services to individuals, commercial businesses, nonprofit entities and estates and trusts. I also provide compilation and review services. I lead the Tax Committee and am a member of the Information Technology Advisory Committee.

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