By Ian Aguilar, CFP®
The American Opportunity Tax Credit, or AOTC, allows for people to receive a maximum annual credit on their taxes of $2,500 per eligible student. This means the government is willing to grant ten thousand dollars (over four years) of tax credits to every qualifying student. If you have three kids, this equals $30,000 of college expenses you can shift back over to Uncle Sam versus coming out of your own pocket.
Generally, the tax credit can be used by most families paying for their children’s college education, but there are a few stipulations you should take into account when claiming this tax credit.
Which Students Are Eligible?
First, the student needs to be deemed an eligible student. This requires a small checklist of items where the student must:
– Be pursuing a degree or other recognized education credential;
– Be enrolled at least half-time for at least one academic period beginning in the tax year;
– Not have finished the first four years of higher education at the beginning of the tax year;
– Not have claimed the AOTC or the former Hope credit for more than four tax years; and
– Not have a felony drug conviction at the end of the tax year.
Which Expenses Are Qualified?
Second, the same student can’t also be claiming the other educational tax credit, known as the Lifetime Learning Credit (LLC). The Lifetime Learning Credit is another educational tax credit, but it is a smaller credit than the AOTC and does not grant for some of the credit to be refundable. Under the AOTC, up to $1,000 of the tax credit is refundable to the filer. It’s important to note the expenses being quoted to obtain the credit must be tuition and/or other qualified expenses, which includes things like books, supplies, and equipment needed for a specific course of study. It’s also important to note room and board is not included in what is covered.
How to Structure Payments to Colleges in Order to Qualify
Third, qualifying educational expenses cannot be paid with money from tax-advantaged accounts, such as 529 plans. The use of such funds will disqualify those expenses for the tax credit. All too often, people who use 529 plans front load their usage because they are unaware of how the AOTC can benefit them. For example, say tuition is $25,000 per year, and someone with $50,000 in their 529 plan decides to use all of the funds to pay for the first two years of their child’s education and then pays the rest out of pocket. By doing this, the family misses out on the ability to claim the AOTC for all four years of their child’s education. Instead, if the funds from a 529 plan are spread out over the four years evenly, the family would not only gain $5,000 more in tax credits, but would also have two more years of growth for the remaining funds in their 529 plan.
What If Your Income Is Too High?
Lastly, an income limit is applied when determining who qualifies for this tax credit. To qualify for the full amount of the AOTC, your modified adjusted gross income must fall under $80,000 for single filers and $160,000 for married filing jointly. You become completely phased out when your income is over $90,000 and $180,000, respectively. It is important to note for families that make only 10%-20% more than the limits that this is in relation the modified adjusted gross income, and that you can utilize certain strategies, such as retirement plan contributions, to help qualify for this tax credit while also having the side effect of lowering your taxes-all while saving money for retirement!
Often times, people fall too high on the income scale in order to take advantage of the AOTC. This is where some out-of-the-box thinking can still help provide people the ability to capture the “free” money from Uncle Sam. If the idea of acquiring any type of financial aid is completely off the table, then looking to utilize the tax capacity of your child may make the most sense. This would require your child to not be listed as your dependent on your tax returns and to have them claim the actual tax credit his/herself. In order to do this, the child needs to provide for over 50% of his or her own support. This can be done in a few different ways, from the child selling stock that has been gifted at least one year in advance of the child’s need for education, being employed on their own, or even through working for their parent’s company.
We’d be happy to help you organize your financial picture to see how to best utilize the AOTC in your college funding plan. Please call us at (904) 273-9850 or email Ian Aguilar at Ian@BandCfinancial.com to learn more.