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Origin of the American Opportunity Tax Credit

The American Opportunity Tax Credit, proposed by President Barack Obama and passed by Congress in 2009 to replace the Hope Credit, became a permanent education tax credit with the passage of the PATH Act of 2015.

How Does the American Opportunity Tax Credit Work?

Per the IRS, for parents or students paying for higher education and earning less than $80,000 per year of modified adjusted gross income ($160,000 MAGI married filing jointly), there is a credit up to 100% of the first $2,000 of qualified education expenses paid for (or by) the student and 25% of the next $2,000 of qualified education expenses, for a total tax credit of up to $2,500 per year.

Note that there is a phaseout of the credit up to $90,000 MAGI ($180,000 married filing jointly), and beyond that income level you cannot claim the credit.

What If You Don’t Qualify for the American Opportunity Tax Credit?

Most of the dual-income households that I work with are unfortunately not eligible to claim the American Opportunity Tax Credit (“AOTC”) on their tax returns because of the IRS income limitations.

Similar to the back door Roth IRA strategy that I wrote about previously, there are legal and ethical ways to work around those income limitations.

For example, many of our families have students that work while in college (i.e. after age 18) and earn a decent income that is less than $80,000 per year. As long as the parents do not claim that child as a dependent on their tax return, the student should be able to claim the AOTC as long as they meet the eligibility requirements.

AOTC Eligibility Requirements

  • The student is pursuing a degree or other recognized education credential
  • The student is enrolled at least half time for at least one academic period beginning in the tax year
  • The student must not have finished the first four years of higher education at the beginning of the tax year
  • The student must not have claimed the AOTC or the former Hope credit for more than four tax years
  • The student must not have a felony drug conviction at the end of the tax year

AOTC Is Partially Refundable

A very cool benefit of the AOTC is that up to 40% of the credit is refundable. IRS rules state that 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.

Accessing the American Opportunity Tax Credit

For documentation purposes, the law requires that the student have their 1098-T Tuition Statement from the school to allow them to complete Form 8863 which must be attached to their tax return to receive the credit come tax time. For more details, please visit https://www.irs.gov/credits-deductions/individuals/aotc.

As always, we recommend that everyone consult with a tax advisor regarding this and any other tax strategy that is considered.

With the costs of higher education being as high as they are and steadily increasing each year, we feel strongly that the best college funding plan involves the coordination and integration of multiple strategies to help reduce the out-of-pocket costs for parents that one day want to also retire comfortably. On behalf of all of us here at The College Funding Coach®, we hope that this blog was helpful as you plan wisely for the future.

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Author:

James L. Hicks, CFP®, ChFC®, ChSNC™, CFBS, CLU®, MBA

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For a list of common questions on the AOTC, checkout out the IRS FAQs.

Related Reading:

Stuck in the Middle: How Roth IRAs Can Be Used for College Funding

14 Ways to Minimize Student Loans

Save for Retirement or Pay for Your Kids’ College?

Paying for College Without Parents’ Help

 


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