It seems that tax season comes around sooner and sooner each year. That can actually be a good thing if you incorporate tax planning into your college-planning strategy. One of the best ways to do this is to utilize the American Opportunity Tax Credit. With this tax credit, you can potentially receive up to $10,000 toward the cost of your children’s college. Do you qualify? Let’s take a closer look and find out.
The American Opportunity Tax Credit, or AOTC, is one of many tax planning strategies that can help defray the cost of college. The credit is up to $2,500 each year. It can be claimed for every child that attends college, even if you have multiple children in college at once. Below are the requirements to claim the credit:
- The student has not completed the first four years of post-secondary education and has been enrolled at least half time for at least one academic period as of the beginning of the taxable year
- Income phase-out for claiming the AOTC is $160,000 – $180,000 of modified adjusted gross income on joint tax returns ($80,000 – $90,000 for single tax filers and heads of household)
- Credit is calculated on 100 percent of the first $2,000 in qualified expenses, plus 25 percent of the next $2,000
- Qualified expenses include tuition and related expenses (not room and board) at college, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education
Avoid the Double Dip
The amount of your qualified educational expenses will be reduced if you pay for those expenses with scholarships, grants, or other forms of tax-free assistance. So be careful and ensure that you have an ample amount of expenses to claim the credit.
For example, if tuition is $8,000 and the student receives a $5,000 scholarship, then that leaves only $3,000 of qualified expenses to claim the AOTC.
Along those same lines, you need to be careful when taking distributions from education savings accounts such as 529s and claiming the credit in the same year. The same expenses that you use to calculate your credit cannot be used against your tax-free 529 distributions.
In other words, if you took $4,000 from your 529 account to pay for tuition expenses, you would be unable to use the same $4,000 in expenses to claim the AOTC.
For starters, make sure that you have enough qualified expenses to claim the AOTC. If you plan on taking 529 distributions, then you will have to add up all of your expenses to determine eligibility for both the AOTC and tax-free 529 withdrawals.
Some expenses such as room and board are not considered qualified for AOTC purposes, so be sure to assign expenses to the appropriate strategy. If you have a limited amount of qualified expenses, then focus on the AOTC first since that provides the greatest benefit.
If you make too much money to claim the credit on your own return, then determine if your child can take the credit on theirs.
Children who pass the support test — meaning they use their assets, income, and student loans to pay more than half the cost of college — can claim the personal exemption on their own tax return. This in turn allows them to claim the credit for themselves.
The increases in college tuition have made it more and more difficult for families to pay the cost. Most have resorted to loans and raiding their retirement assets to fill the gaps. But this doesn’t have to happen. Be proactive and understand what your options are. Ask yourself:
- Is community college a good fit for my child?
- Where will my child qualify for the most financial aid?
- Will gifting appreciated assets to my child save us money and help pay for college?
- Should our home equity line be used to pay for college?
A Final Thought
These are just a few questions than can help shape your college planning strategy. A strategy that should not only cover tax aid, but also college selection, financial aid, and the best use of your personal resources. Doing so will go a long way toward helping your child receive a quality education, minimize their student loans, and protect your retirement.