The American Opportunity Tax Credit is usually the best tax benefit available to families. But it has some rules you should be aware of in order to make the most of it.
The AOTC is worth up to $2,500 per year, per student, for four years. To claim it, the family must spend $4,000 on qualified expenses from a non-529 source. (That’s because 529s are considered tax advantaged and the IRS only allows one tax benefit per dollar.) And that’s where the rules come in. Many of them.
First and foremost, you can claim the AOTC four times per student, but a student who graduates in four years will be in college during five tax years. That means you have to choose which four years, and understanding the rules will help you to choose.
Most important right now is this: You have to pay the expense in the year that you claim the AOTC. If your student is a freshman in college and you’re planning to claim it, make sure you’ve paid enough in qualified expenses before the end of 2020 to claim it. That might mean paying your tuition for the winter term early if it’s not due before 12/31.
Qualified expenses for AOTC purposes are a bit more limited than for 529s: Only “tuition, fees and other related expense for an eligible student that are required for enrollment or attendance at an eligible educational institution,” “student activity fees you are required to pay to enroll or attend the school,” and “books, supplies and equipment the student needs for a course of study.” What’s not on that list? Room and board, health insurance, transportation, … So a student with a scholarship that covers a large portion of their tuition might need to be somewhat deliberate about scheduling tuition payments in order to take full advantage of the AOTC.
The other big AOTC rule is its income limit: single taxpayers must have AGI below $80,000; eligibility for married filing joint phases out starting at $160,000 AGI. 401k, IRA or HSA contributions can help families bring their income below that threshold; if you’re close, check your contributions and adjust if possible or plan on adjusting for next year since it may be too late now.
Divorced parents where only one parent is eligible to claim the AOTC might decide to plan around that, rather than what their divorce decree states. Only the parent claiming the student on their tax return can claim the AOTC. With the AOTC worth five times the dependent credit, families benefit from adjusting to take advantage of it.