The American Opportunity Tax Credit (AOTC) allows eligible parents to claim an annual tax credit of up to $2,500 per student to help cover college costs. The AOTC is also available to dependent students, as long as certain income and other criteria are met. Tax-free distributions from a 529 plan are limited to qualified expenses that were not counted toward the AOTC.
How the American Opportunity Tax Credit works
The AOTC, which replaced the Hope Scholarship credit in 2009, is a partially refundable tax credit that can be claimed for college expenses such as tuition, fees and required course materials (e.g., textbooks). The AOTC was made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015.
The AOTC is equal to 100% of the first $2,000 spent on qualified education expenses plus 25% of the next $2,000 for a maximum $2,500 tax credit per student. Eligible taxpayers may claim the AOTC in up to four tax years.
Graduate students and continuing education students may be eligible to claim the Lifetime Learning Tax Credit. Taxpayers may claim either the AOTC or the Lifetime Learning Tax Credit in a given tax year.
Who is eligible to claim the AOTC?
Dependent students or parents of dependent students who meet the following requirements are eligible to claim the AOTC:
- The taxpayer’s modified adjusted gross income is $90,000 or less ($180,000 if married filing jointly). The credit phases out for taxpayers with income between $80,000 and $90,000 ($160,000 and $180,000). The income phase-outs do not change.
- The tax credit is limited to the first four years of postsecondary education and to four tax years per student
- The student is pursuing a degree or certificate program leading to a recognized education credential at a college or university that is eligible for Title IV federal student aid
- The student is enrolled on at least a half-time basis for at least one academic period during the tax year for which the AOTC is claimed
- The student has never been convicted of felony drug charges
- The student’s parents have not improperly claimed the AOTC in a prior tax year
Qualified expenses for the AOTC
Qualified expenses for the AOTC include tuition, fees and course materials that are required for enrollment or attendance at an eligible post-secondary education institution. Room and board costs, transportation, sports fees or other non-academic expenses are not qualified expenses for the AOTC.
Other qualified expenses include:
- Course materials include required textbooks, supplies and equipment
- Qualified expenses purchased with student loan proceeds
- Qualified expenses that were not refunded when a student withdraws from an eligible institution
- Qualified expenses paid in the current tax year for an academic period beginning within three months of the following tax year
Parents and dependent students who paid for tuition and other qualified expenses during a given tax year will receive Form 1098-T from the college or university the student attended. Form 1098-T will list the tuition, fees and other expenses required for enrollment that can be used to claim the AOTC.
How to claim the AOTC
To claim the AOTC, taxpayers must complete and submit Form 8863 with their federal income tax return. The parent and student will both need a Social Security Number or Individual Taxpayer Identification Number (ITIN) that was issued on or before the due date for the federal tax return. The taxpayer will also need the college or university’s employer identification number (EIN), which can be found on Form 1098-T.
The AOTC is partially refundable. If the amount of the AOTC is greater than the taxpayer’s tax liability, the taxpayer may receive a refund of up to 40% of the excess credit (maximum $1,000). A student who claims the AOTC who can be claimed as an exemption on a parent’s federal income tax return is not eligible for the partial refund. For example, if the parent's income exceeds the income phase-outs, but the student's income does not, the student could claim the AOTC, but only to the extent that it does not exceed the student's tax liability.
Coordinating the AOTC with 529 plan distributions
Taxpayers may claim the AOTC in the same year a tax-free distribution is made from a 529 plan or Coverdell Education Savings Account as long as there is no double-dipping. Different expenses must be used to justify the AOTC and a tax-free distribution from a 529 plan. For example, families who claim the maximum AOTC and have $12,000 in qualified education expenses in a given tax year may withdraw $8,000 tax-free from a 529 plan.
$12,000 - $4,000 (used to generate the AOTC) = $8,000 tax-free 529 plan distribution
If the student receives any tax-free scholarships, Veteran’s educational assistance, employer-provided education assistance or any other tax-free educational assistance, the amount of the benefit must also be subtracted from the total amount of qualified education expenses.
Since the AOTC is worth more per dollar of qualified expenses than a tax-free distribution from a 529 plan, it is best to allocate $4,000 in tuition and textbook expenses for the AOTC before taking a tax-free distribution from a 529 plan.