Clients who are paying for college may be eligible to claim the American Opportunity Tax Credit, worth up to $2,500 per child, and with the credit's phaseout now at $180,000 of modified adjusted gross income, more parents are eligible.
However, claiming the credit requires coordination with distributions from Section 529 college savings plans and Coverdell education savings accounts.
The AOTC is worth up to $2,500 per student each year for four academic years, extended through the 2017 tax year. But families that earn too much can't claim the credit.
The income phaseout for claiming the AOTC is $160,000 to $180,000 of modified adjusted gross income on joint tax returns ($80,000 to $90,000 for single tax filers and heads of household). The amount of the credit is calculated as 100% of the first $2,000 in qualified tuition and fees paid, plus 25% of the next $2,000 paid for such fees.
For lower-income taxpayers who don't owe $2,500 in tax, up to $1,000 of the credit is refundable. The credit isn't refundable on a dependent child's return.
Clients can use Internal Revenue Service Form 8863 to claim the AOTC, which is based on qualified college expenses they pay for themselves, their spouses or dependents for whom they claim an exemption on their tax returns.
According to IRS Publication 970, qualified education expenses are tuition and related expenses required for enrollment or attendance at an eligible educational institution.
Such an institution is any college, university, vocational school or other post-secondary educational institution eligible to participate in a student aid program administered by the Education Department. It includes virtually all accredited public, nonprofit, and proprietary or privately owned profit-making post-secondary institutions.
The credit can't be claimed for college credits taken under dual-enrollment programs, where high school students are simultaneously enrolled in college courses.
The reason is that high school students aren't technically enrolled in a degree-granting program because they don't yet have a high school diploma, even though they are earning college credits, according to the Education Department.
It doesn't make any sense, but that is the rule.
Related expenses are student activity fees and expenses for course-related books, supplies and equipment that are required as a condition of enrollment or attendance. The amount of qualified educational expenses that can be used in calculating these tax credits is reduced if a client pays for the qualified expenses with certain tax-free funds, including:
• Tax-free portions of scholarships and fellowships.
• Pell grants.
• Employer-provided educational assistance (Section 127 tuition reimbursement plan).
• Veterans' educational assistance.
• Any other tax-free payments received as educational assistance.
It is very important to remember that clients can't claim any of the college tax credits, including the AOTC, based on expenses that were used to calculate the tax-free portion of a distribution from a 529 or prepaid plan, or a Coverdell ESA. The AOTC may be claimed in the same year that a tax-free distribution is made, as long as the same expenses aren't used to calculate the tax-free distribution and the AOTC.
For example, if a client takes $12,000 out of a 529 plan to pay for tuition, that client can't use that $12,000 of tuition expenses to claim the AOTC also. This coordination-of-benefits provision is why it helps to have a tax preparer who understands education funding so that the client can make the most of the benefits for which he or she qualifies.
Even more important, however, is to discuss with clients ahead of time how they will pay for college to best coordinate how to use the income and assets available and still be eligible to claim the full amount of college tax credit for which the client is eligible.
For clients who aren't able to claim the AOTC because their income exceeds the $180,000 MAGI phaseout threshold, their child might be able to claim the credit on his or her own tax return. If clients can't or don't claim the AOTC or any other tax credit, or the tuition and fees deduction, and also don't claim that child as a personal exemption on their tax returns, their children can claim the AOTC on theirs.
Troy Onink (troy.onink @stratagee.com) is the chief executive of Stratagee Corp., which provides college planning approaches.