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What Is the American Opportunity Tax Credit?

By Matthew Frankel, CFP® – Apr 9, 2017 at 6:03PM

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If you pay tuition or other college expenses, this tax credit could boost your refund by up to $2,500.

The American Opportunity Credit is one of three tax breaks designed to help make paying for higher-education expenses more affordable for Americans. While it's potentially the most lucrative of the three, it also has the most restrictions. Here's what you need to know about the credit, how to determine if you qualify, and the other tax breaks available if you don't meet the American Opportunity Credit's strict requirements.

The American Opportunity Tax Credit

The American Opportunity Tax Credit is designed to help low- to middle-income taxpayers afford higher-education expenses, either for themselves or a dependent.

Group of college students gathered around a laptop.

Image source: Getty Images.

Of the three potential tax breaks for tuition and fees (more on the other two later), the American Opportunity Credit is generally the most lucrative, and therefore has the most stringent requirements.

To claim the credit, the student must be in the first four years of postsecondary education and must be enrolled in a degree or certificate program, taking classes on at least a half-time basis. In addition, the credit has income restrictions. The credit begins to phase out for modified adjusted gross income above $80,000 for single taxpayers and above $160,000 for married taxpayers filing jointly.

If you qualify, the American Opportunity Credit is worth up to $2,500 per year. It is worth 100% of the first $2,000 in qualifying expenses, and 25% of the next $2,000. In other words, if you have $4,000 or more in qualifying higher-education expenses, which we'll define in the next section, you can get the full $2,500 tax credit, provided you meet the requirements. In addition, up to $1,000 of the credit is refundable, meaning that you can get it even if you have no federal income tax liability.

What expenses qualify?

Obviously, tuition is a qualifying higher-education expense. Tuition paid during the tax year qualifies, so if you paid tuition in December 2016 for the Spring 2017 semester, you can use that to figure your 2016 credit. The rule is that the tuition you pay must be for a period beginning during the calendar year, or during the first three months of the following year. In other words, you can't prepay your summer 2017 tuition in December 2016 and use it toward the credit.

In addition to tuition, student activity fees paid directly to the institution as a condition of enrollment qualify. Books, supplies, and equipment needed for a course of study are also allowed, even if not purchased from the educational institution.

To qualify the expenses must be paid to an eligible institution, which generally refers to any accredited public, nonprofit, or for-profit college, university, or vocational school that is eligible for a U.S. Department of Education student-aid program.

Other options if you can't claim the American Opportunity Credit

As I mentioned, the American Opportunity Credit is the most lucrative education tax break, but is also the most difficult to qualify for. If you paid tuition or other qualifying expenses, but don't meet the strict requirements of the American Opportunity Credit, there are two other tax breaks you might be able to get instead.

The Lifetime Learning Credit is typically the next best option for those who qualify. Unlike the American Opportunity Credit, the student does not need to be in the first four years of post-secondary education, nor does he or she need to be pursuing a degree or certificate. Furthermore, there is no half-time enrollment requirement.

The result of this flexibility is that the Lifetime Learning Credit is available to many more taxpayers. For example, if you decide to take a class at your local community college for the sole purpose of enhancing your job skills, that's a qualifying expense.

The Lifetime Learning Credit is worth a maximum of $2,000, and is calculated as 20% of qualifying expenses, up to a maximum of $10,000. The drawback is that the credit has lower income thresholds -- it begins to phase out above MAGI of $55,000 for single filers and $111,000 for married filing jointly, and disappears completely above thresholds of $65,000 and $131,000, respectively. Another drawback is that there is a stricter definition of qualified expenses than the American Opportunity Credit. Tuition and required fees qualify for the credit, but expenses such as books, supplies, and equipment only count if they must be paid directly to the institution as a condition of enrollment.

Finally, the tuition and fees deduction can be used for higher-education expenses without the restrictions of the American Opportunity Credit, but with higher income thresholds ($65,000/$130,000 phase-out for single and joint filers). In addition, the definition of qualified expenses is the same as the Lifetime Learning Credit.

For those who qualify, the tuition and fees deduction can reduce the amount of income subject to tax by up to $4,000.

An excellent tax credit -- if you qualify

The American Opportunity Credit is the most lucrative of the three main tax breaks for education expenses, but it also has the strictest requirements, and is not available to many people who paid higher education expenses. For those who qualify, however, the credit can put up to $2,500 of their hard-earned tax dollars back in their pocket. 

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