In the course of your tax planning, it's important to jump on as many opportunities as you can to pay the IRS less (legally, of course). And in this regard, tax credits are really your friend.

A tax credit is a dollar-for-dollar reduction of your tax liability. If you owe the IRS $2,000 but are eligible for a $2,000 tax credit, that debt is suddenly wiped out. And if you're a student, you may have an opportunity to eke out some tax savings via the American Opportunity Tax Credit (AOTC).

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What is the AOTC?

The AOTC is a tax credit designed to help defray the cost of higher education. The Protecting Americans Against Tax Hikes (PATH) Act of 2015 made the AOTC a permanent fixture of the tax code, but qualifying hinges on certain criteria.

To be eligible for the AOTC, you must be:

  • Enrolled in higher education on at least a half-time basis
  • Be completing one of your first four years of post-secondary education

On that latter point, you can only claim the AOTC for up to four years. However, those years don't need to be consecutive. If you take a break from your studies after two years and resume your studies several years later, you'll still be eligible provided you meet the other criteria.

What are eligible AOTC expenses?

The AOTC covers a range of expenses associated with higher education. These include:

  • Tuition
  • Enrollment fees
  • Books
  • Supplies and equipment

Some of the expenses you incur in the course of your studies are not eligible for the AOTC. These include:

  • Room and board
  • Transportation
  • Student health fees

How much is the AOTC worth?

The AOTC is worth 100% of the first $2,000 of qualified higher education expenses you incur and 25% of your next $2,000 of qualified higher education expenses. This means that all told, the credit could be worth up to $2,500 a year.

Furthermore, some tax credits are refundable, which means they'll pay you back even if your tax liability is $0. The AOTC is 40% refundable, so even if you don't owe the IRS any money, you could still be in line for up to $1,000, which is 40% of the credit's maximum value.

Are there income limits associated with the AOTC?

There sure are, though they're reasonably generous. To claim the credit in full, you'll need a modified adjusted gross income (MAGI) of $80,000 or less if you're single, or $160,000 or less if you're married filing a joint tax return. You can qualify for a partial credit if your MAGI exceeds $80,000 but does not exceed $90,000 as a single filer, or if your MAGI exceeds $160,000 but does not exceed $180,000 as a couple filing jointly.

Know your tax credits

The AOTC is just one of many tax credits available to filers today. It pays to read up on the different credits you may be entitled to so you can reap additional savings and shield as much of your income as possible from the IRS's reach.