American Opportunity Tax Credit

Allison Martin
woman working from home

According to IRS.gov, the American Opportunity Tax Credit (AOTC) is "a credit for qualified education expenses paid for an eligible student for the first four years of higher education." The maximum credit you can receive is $2,500, or 100 percent of the first $2,000 paid in eligible expenses and 25 percent of the next $2,000 paid.

History of the AOTC

Prior to 2009, the AOTC was known as the Hope Credit and could be claimed by students for two years. Under the American Recovery and Reinvestment Act (ARRA), the Hope Credit became the AOTC for tax years 2009 and 2010. It was extended to 2012 under the Tax Relief and Job Creation Act of 2010 and will remain intact through tax year 2017 under the American Taxpayer Relief Act of 2012.

How it Works

Like other tax credits, the AOTC provides a dollar for dollar reduction to your tax liability. So, if you have an outstanding tax liability of $800 and are eligible for tax credits that equal $500, your remaining tax liability will be $300.

Per IRS guidelines, up to 40 percent of the credit remaining after your tax liability is eliminated is refundable. For example, if you have $2,500 in qualified education expenses and a tax liability of zero after the credit is taken, you can receive a refund of up to $1,000.

To illustrate:

Tax Liability Before AOTC Is Taken

Paid Qualified Education Expenses

Amount of AOTC

Tax Liability After AOTC Is Taken

Amount Eligible for Refund

Calculation

$2,200

$1,000

$1,000

$1,200

$0

Not eligible for refund because a tax liability still exists

$1,400

$2,000

$2,000

($600)

$240

= $600 * .40

$1,000

$2,500

$2,125

($1,125)

$450

= $1,125 * .40

$3,000

$5,000

$2,500

$500

$0

Not eligible for refund because a tax liability still exists

Qualification Criteria

To qualify for the AOTC, you must meet the following criteria:

  • Be degree-seeking student (or working toward another recognized education credential) for a minimum of one academic period during the tax year. Enrollment may be full- or part-time.

  • Have a modified adjusted gross income (MAGI) of no more than $80,000 if filing on your own, or $160,000 or less if you are married and filing jointly. However, a reduced credit is available if your MAGI falls between $80,000 and $89,999. In most instances, your MAGI will be the same as your Adjusted Gross Income found on Form 1040, 1040A or 1040EZ.

If you have completed four years of higher education, claimed the AOTC or Hope credit for more than four tax years, or have ever had a felony drug conviction, you do not qualify.

Cost-Benefit Analysis

As always, there are pros and cons with this credit.

Key Benefits

The process of claiming the AOTC is not complicated. It is particularly easy to claim when using tax software as the program will compute the correct amount for you.

In addition, depending on your tax situation, you have the potential to receive a refund of up to $1,000 as a result of the AOTC if you qualify.

Key Limitation

Unfortunately, the calculation used to determine how much your AOTC will be only considers up to $4,000 in paid qualified education expenses. It is not unusual for out-of-pocket higher education costs to be substantially higher.

Claiming the AOTC

To claim the AOTC, refer to Form 1098-T, which is the Tuition Statement received from the institute of higher education you are attending. Use the figures from this form to Complete Form 8863, which must be submitted when filing your tax return. Be sure to refer to the instructions for Form 8863 to confirm you can claim the expenses listed on your Tuition Statement.

If you need additional assistance after reviewing the instructions, contact a licensed tax professional.

Beneficial Tax Break for Students

Overall, the AOTC program provides a way to reward people for seeking higher education by reducing their tax liability. Whether the credit reduces your tax bill or results in a refund, the end result is a positive impact on your personal finances.

American Opportunity Tax Credit