What’s the American Opportunity Tax Credit (AOTC)?

The American Opportunity Tax Credit (AOTC) is a tax credit for the first four years of higher education expenses generally available to students, spouses, and parents (whoever is paying the educational expenses for a student). The AOTC is worth up to $2,500 annually per student for the first $4,000 you spend on qualifying educational expenses for yourself, your spouse, or your dependents.

Now that you have a rough idea of this tax credit, let’s break down exactly how it works and how to know if you may be eligible for it.

How does the American Opportunity Tax Credit work?

The AOTC is based on qualified educational expenses. These education expenses must be paid for by you on behalf of yourself, a child, or a spouse. The following may be eligible expenses for the AOTC per the Internal Revenue Service (IRS):

• Tuition at an eligible educational institution
• Certain expenses and student activity fees that are required for enrollment or attendance at an eligible educational institution
• Expenses for books, supplies, and equipment that are deemed necessary for school

The following aren’t qualified expenses:

• Insurance
• Medical expenses (including student health fees)
• Room and board
• Transportation
• Personal, living, or family expenses

If you receive tax-free educational assistance, that amount must be subtracted from your qualified education expenses.

How much is the AOTC credit amount?

The AOTC can be worth up to $2,500 annually per student for the first $4,000 you spend on qualified educational expenses on behalf of yourself, your spouse, or your dependents for the first four years of education completed after high school.

The credit translates to $2,000 of the first qualified education expenses you pay and 25 percent of the next $2,000.

In some cases using the credit will bring the amount of tax you owe to zero. In this case, you can have a portion of the remaining amount of the credit refunded to you. This potential refund is limited to $1,000.

Who’s eligible for the AOTC?

According to the IRS, to be eligible for the AOTC, the student that the credit is being claimed because of must:

• Be pursuing a degree or another recognized education credential
• Be enrolled at least half-time for at least one academic period (this is determined by schools) at the beginning of the tax year
• At the beginning of the tax year, not have finished four years of higher education
• Not have claimed the AOTC for more than four tax years
• Not have claimed the Hope Credit — though it no longer exists — for more than four tax years
• Not have a felony drug conviction at the end of the tax year

Students, parents, or spouses can claim the tax credit – whoever is paying for the student’s educational expenses. However, students listed as a dependent or spouse on another tax return may not claim the credit.

What are the income limits for the AOTC?

There are income limits in regards to who can claim the AOTC. The income limits for the AOTC are as follows:

• To claim the full AOTC, your modified adjusted gross income (MAGI) must be $80,000 or less. In the case of those married or filing jointly it’s $160,000 or less
• You’ll receive a reduced AOTC if your MAGI is over $80,000 but less than $90,000. In the case of those married and filed jointly it’s over $160,000 but less than $180,000
• You won’t be able to claim the credit if your MAGI is over $90,000, and in the case of joint filers, $180,000

For reference, MAGI is the adjusted gross income shown on most people’s tax returns. The IRS makes worksheets available to help you understand your MAGI. If you file Form 1040, you may need to add additional amounts to your adjusted gross income. Check the guidelines provided by the IRS for more information.

How do you “apply” for the AOTC

You don’t “apply” for the AOTC like you would a scholarship — it’s something to claim on your taxes should you be eligible. To claim the AOTC, you must file a federal tax return, complete Form 8863, and attach the completed form to your Form 1040 or Form 1040A.

Use the information on the Form 1098-T Tuition Statement received from an educational institution. The form includes:

• The institution’s federal identification number
• Payments received
• Amounts billed or refunds made for tuition and related expenses
• Scholarships administered by the institution that were received
• The student’s enrollment and graduate status

Eligible educational institutions must issue Form 1098-T for each enrolled student for whom there’s a reportable transaction.

One thing to be aware of is that you can’t take the AOTC and the Lifetime Learning Credit in the same tax year for a student's same qualified expenses.

Final thoughts

While the AOTC tax credit is a fantastic opportunity if you’re eligible, it’s important to ensure you’re eligible before claiming the credit, or you could face serious repercussions. If the IRS audits your tax return and finds that you aren’t eligible for the credit, you’ll have to pay the amount of the AOTC you received back with interest. You might also be charged an accuracy or fraud penalty or banned from claiming the AOTC credit for up to ten years.