New Law Breathes Five More Years of Life Into Important Education Tax Credit

The American Taxpayer Relief Act, which resolved the so-called “Fiscal Cliff” impasse, gave new life to several programs set to expire at the end of 2012. Once such program was the American Opportunity Tax Credit (AOTC), which can provide substantial benefits to middle and lower-income families putting a child through college.

In 2009, the American Recovery and Reinvestment Act, commonly known as the “stimulus act,” created the AOTC, and made it available for up to four years of undergraduate study. In addition to the AOTC, the tax code also offers two other credits related to college expenses: the Lifetime Learning Credit and the Hope Scholarship Tax Credit. Families may claim only one credit per eligible child during each year. For families with full-time undergraduate students, the AOTC stands out because it has the highest maximum, at $2,500 per student, versus $2,000 and $1,800, respectively, for Lifetime Learning and Hope. Families with part-time or graduate students are ineligible for the AOTC, but remain eligible to claim the Lifetime Learning Credit.

The AOTC does, however, have income phase-outs. The phase-out starts kicking in at $160,000 of modified adjusted gross income (MAGI), in cases of a joint return. That number sits at $80,000 for single and head-of-household filers. Families with a MAGI above $180,000 (joint returns,) and $90,000 (single and head-of-household filers) are ineligible to claim the AOTC. The restrictive nature of these phase-outs led foxbusiness.com to opine that “if you can afford to send your kids to college, you won’t get the credit.”

The amount of the AOTC (per eligible student) equals 100% of the first $2,000 of qualified education expenses, and 25% of the next $2,000 of qualified education expenses. So, as an example, if the Smiths have a MAGI of $76,000, file a joint return, and paid $3,000 in university tuition for their daughter, they could claim a credit of $2,250. If the expenses had totaled $4,000 or more, they could claim the maximum $2,500 credit.

Eligible expenses include tuition at any college, university, vocational institution, or other school eligible to participate in the federal student financial aid program. The cost of student-activity fees and course-related books, supplies, and equipment required by that institution or professor also constitute qualified expenses. Take note, though, that the code strictly prohibits families from claiming the credit for “dual enrollment” students who take college courses while still enrolled in high school. Another important fact to keep in mind is that expenses paid through a distribution from a 529 plan or Coverdell education savings account are ineligible for the credit. For example, if a family expends $11,000 in a year for college expenses, but pays that entire amount through a distribution from a 529 plan, they cannot claim the AOTC. If, however, the 529 distribution was only $7,000, then that family could claim the credit on the remaining $4,000, and receive the maximum $2,500 credit.

The tax attorneys at Samuel C. Berger, P.C. and the CPAs at S.C. Berger, P.C. are here to assist families in New York and northern New Jersey who have students in college, as those families seek to minimize the financial burden of helping their children better themselves and reach their dreams. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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