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What Is the American Opportunity Tax Credit?

By Selena Maranjian - Jun 5, 2016 at 2:40PM

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This tax break can cut thousands of dollars off your taxes for education expenses.

It's reasonable to be stressed out about the cost of college these days. According to data from The College Board, the average in-state cost of tuition, fees, and board at a four-year public college is $19,548 for the 2015-2016 school year -- and it's a whopping $43,921 at a four-year private college. Yikes!

Fortunately, the IRS is standing ready to help you with those onerous higher-education expenses via the American Opportunity Tax Credit (AOTC).

What the American Opportunity Tax Credit offers

In a nutshell, the American Opportunity Tax Credit offers a tax credit of up to $2,500 per eligible student for qualifying higher-education expenses. Specifically, it offers a credit of 100% of the first $2,000 of qualified expenses, and a credit of 25% of the next $2,000 of qualified expenses. So if you have at least $4,000 of qualified expenses, you may claim the full $2,500 credit.

Take a moment to appreciate how powerful this can be. After all, it's a tax credit, not a mere deduction. If you received a $2,500 deduction and were in the 25% tax bracket, you could avoid paying 25% on $2,500 of expenses, saving a solid $625. But if you had a $2,500 tax credit, it would reduce your tax bill dollar by dollar! You could cut your tax bill by a whopping $2,500.

The AOTC might even get you a tax refund. Image: frankieleon, Flickr.

The American Opportunity Tax Credit is even better than some other credits because it's partially refundable. Many credits are not refundable, meaning that if your tax bill is $2,000 and the credit is $2,500, you'll wipe out the tax owed, but won't get any benefit from the remaining $500 of the credit. If that credit were refundable, you'd get a $500 tax refund.

The AOTC was recently the only partially refundable credit, offering a refund of 40% of any remaining credit once your tax owed was reduced to zero. (In other words, if your tax owed was $2,000 and the credit was $2,500, you'd get 40% of the $500 -- $200 -- refunded to you.)

The AOTC is also powerful because it's worth up to $2,500 per eligible student. That can bring a lot of tax relief to large families.

Eligibility for the American Opportunity Tax Credit

Of course, as with most tax-related things, there are rules. For starters, not every student will be eligible. The AOTC requires  that the student should:

  • be taking courses toward a degree or some other recognized education credential
  • be enrolled at least half-time for at least one academic period beginning in the tax year in question
  • not have completed four years of higher education as of the beginning of the tax year
  • not have a felony drug conviction by the end of the tax year

In addition, the AOTC is only available for up to four years per student. If the student in question has already claimed it (or the former Hope credit) for four years, it can't be claimed.

The credit is available to you if you pay qualified education expenses for an eligible student, and the student is you, your spouse, or a dependent you claim as an exemption on your tax return. You can't claim the credit, though, if:

  • you're married and file taxes separately
  • you're claimed as someone else's dependent
  • your modified adjusted gross income (MAGI) is $90,000 or more -- $180,000 or more if you're married and filing jointly. (If your MAGI is between $80,000 and $90,000 -- or for those married and filing jointly, between $160,000 and $180,000 -- then you will only qualify for a reduced credit.) 

The expenses that qualify for the American Opportunity Tax Credit include tuition at an accredited educational institution, required books and materials, and required enrollment fees. Note that there's no double dipping. So if you're claiming any educational expenses as, say, a business deduction, then you can't also claim the AOTC.

There are a few other rules to know about, so if you've got qualifying educational expenses, be sure to look into them and see whether it makes sense for you to claim the American Opportunity Tax Credit. If you use the services of a tax pro or tax-prep software, either will likely determine whether you can benefit from it, and will prepare the needed forms, too. Be ready with receipts and/or documentation for any expenses you may claim.

If you've been wondering, "What is the American Opportunity Tax Credit?" -- the answer, in a nutshell, is that it's a tax break that could save you thousands of dollars.

Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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