It’s tax time, which means it’s time to claim education tax credits you may be eligible for. Unfortunately, a lot of tax software programs don’t provide good instructions for doing so, so it’s a good idea to pull up the instructions for Form 8863 and review them before filing.

The American Opportunity Tax Credit is the more valuable of the two credits, offering up to $2,500 in tax credit per undergraduate student per year for four years. To claim it, you must meet the following requirements:

  • Adjusted Gross Income (AGI) below $160,000 (married filing joint) or $80,000 (single/head of household). There’s a phaseout range up to $180,000/$90,000 where you are eligible for a partial credit.
  • Claim the student as a dependent on your tax return.
  • Pay $4,000 of Qualified Higher Education Expenses (QHEEs) in the calendar year for which you are claiming the credit from a non-tax-advantaged source. That means, not your 529 or Coverdell ESA. You can get a partial credit for expenses less than that. Lesser spending levels receive partial credit.
  • You haven’t already claimed it four times for the student. Note that with school years not aligning with calendar years, your student will attend college in five years in which you file taxes.

That sounds reasonably straightforward, but when the time comes to claim it you may find yourself pulling information from multiple sources or inadvertently following incorrect instructions. And that’s where the Form 8863 instructions come in handy.

First, your tax prep software might prompt you to only enter amounts on your form 1098-T. That could be incorrect, for two reasons:

  • If your 1098-T has box 7 checked, it’s showing amounts billed during the calendar year, which may or may not correspond to amounts paid during the calendar year. The AOTC only applies to amounts paid.
  • Your 1098-T only shows tuition and fees paid to (or billed by) your college, net of scholarships. QHEEs for the AOTC include course materials– books, supplies, even a computer and Internet access. Students who receive substantial scholarships might have less than $4,000 on their 1098-T, so families should not overlook these additional expenses.

Form 8863 tells you to add your QHEEs– tuition, fees, books and supplies– then subtract the following to determine your Adjusted qualified education expenses:

  • Tax-free educational assistance including scholarships and grants including Pell grants*
  • Tax-free employer-provided educational assistance
  • Veterans’ educational assistance

In addition, the instructions say, “Any qualified expenses used to figure the education credits cannot be taken into account in determining the amount of a distribution from a Coverdell ESA or a qualified tuition program (section 529 plan) that is excluded from gross income.” In English that means expenses paid by your 529 or ESA also need to be subtracted, or you’ll pay taxes and penalties on the 529 distribution.

The unfortunate thing I’ve experienced with tax prep software is that it simply asks for the amount on your 1098-T and how much you took out of your 529. In many cases, it then shows you owing taxes and penalties on the 529 distribution, rather than being eligible for the AOTC.

* Here’s another tip from the Form 8863 instructions: If your student receives enough scholarships to cover their tuition such that they don’t have adequate QHEEs for the AOTC, they can choose to claim $4,000 of scholarships on their tax return. Depending on their other income for the year, this could result in $0 tax liability *and* allow the family to claim the AOTC.