Many families today are struggling with the cost of higher education for their children. Due largely to a lack of college savings, student loan debt is soaring. There are currently 45 million student loan borrowers in the U.S. who owe a collective $1.5 trillion in education debt. The average student loan borrower now graduates college with a debt burden of more than $26,000.
However, there is some good news when it comes to paying for college. An under-utilized tax break called the American Opportunity Credit can save you up to $2,500 per year on qualified education expenses for your children or even yourself.
Who Can Claim the American Opportunity Credit?
The American Opportunity Credit is available to individuals and families who paid education expenses for a dependent student who is enrolled on at least a half-time basis in an accredited post-secondary institution. The student must be pursuing a degree or other educational credential.
However, the credit phases out once modified adjusted gross income (MAGI) reaches a certain level. For tax year 2019, the MAGI limit to claim the full American Opportunity Credit is $80,000 for single filers or $160,000 for married couples filing jointly. If your MAGI is between $80,000 and $90,000 if you’re single — or between $160,000 and $180,000 if you’re married and file jointly — you can claim a partial credit. Once your MAGI exceeds $90,000 if you’re single or $180,000 if you’re married and file jointly, you’re ineligible for the credit.
The credit can be claimed for any expenses related to the student’s program of study such as tuition, fees, books, supplies and equipment. However, it cannot be claimed for costs associated with a student’s everyday living such as room and board, transportation or health insurance.
How to Calculate and Claim the Credit
The credit is equal to 100 percent of the first $2,000 you spend on qualified education expenses and 25 percent of qualified expenses that exceed $2,000, up to a maximum annual credit of $2,500. Practically speaking, this means that the credit is worth up to $2,500 on the first $4,000 spent on qualified expenses each year.
One of the biggest benefits of the American Opportunity Credit is that it’s refundable. This means that if you owe no federal taxes, you can still receive a credit of up to 40 percent, or $1,000, in the form of a tax refund. The credit can also help offset the alternative minimum tax (AMT) and the self-employment tax.
You should receive IRS Form 1098-T from the qualifying educational institution you paid expenses to no later than January 31 listing the education expenses you paid the previous year. If you received any tax-free education assistance for the student — such as scholarships, fellowships or grants — you must subtract this amount. You’ll then use Form 8863 to calculate the amount of your tax credit and attach this to your 1040 form.
Limitations of the American Opportunity Credit
Note that the American Opportunity Credit can only be claimed during the first four years of college or other qualifying type of higher education. It cannot be claimed for education expenses incurred for graduate studies. Also, you can only claim one credit per eligible student each year.
A different education tax credit — the Lifetime Learning Credit — is available for graduate studies. However, the Lifetime Learning Credit is not refundable. You can’t claim both of these education credits for one student, so if you qualify for both, determine which one offers the most benefit and claim that one. Click here to read more about the Lifetime Learning Credit.
The American Opportunity Credit could help ease some of the pressure of paying higher education expenses for your children. Visit the IRS website to learn more about the American Opportunity Credit.