The American Opportunity credit covers up to $2,500 of undergraduate costs
In 2009, Congress replaced the well-known Hope Scholarship credit with the more generous American Opportunity credit. The new credit is currently available through 2017.
The American Opportunity credit equals 100% of the first $2,000 of a student’s qualified education expenses plus 25% of the next $2,000. The maximum annual credit is $2,500.
Who can claim the credit?
You can claim the American Opportunity credit for qualified education expenses you pay for a dependent child as well as for expenses you pay for yourself or your spouse. If you have several students in your family, you can claim multiple credits based on the expenses of each student. For example, if you have three kids in college, you can claim up to $7,500 ($2,500 x 3) in American Opportunity credits.
The credit is not allowed for a student who has four or more years’ worth of college credits as of the beginning of the year. So, if your child earned less than four years of college credit as of January 1, 2014, you can claim the credit on your 2014 return.
Note: You can only claim the credit for a year during which the student carries at least a half-time course load for a minimum of one semester beginning in that year. Additionally, the student must be enrolled in a program that leads to an associates or bachelors degree or some other recognized credential.
Which expenses are covered?
Expenses covered by the credit include tuition and mandatory enrollment fees and the cost of books and course materials. Room and board do not count as qualified expenses nor do optional fees to cover things like student health insurance, athletics and other activities.
To qualify, students must attend an eligible institution. Almost all accredited public, nonprofit and for-profit postsecondary schools (including many trade schools) fit this description. To make sure a school is eligible, go to fafsa.gov and verify that it has a Federal School Code.
Income phase-out rule
The American Opportunity credit is phased out if your modified adjusted gross income (MAGI) exceeds certain levels. (MAGI is adjusted gross income plus certain tax-free income from sources outside the United States.)
- For 2014, the MAGI phase-out range for unmarried individuals is $80,000 to $90,000.
- The MAGI phase-out range for married couples filing jointly is $160,000 to $180,000.
- Regardless of your income, you are not eligible if you use married filing separate status.
Credit is partially refundable
Your American Opportunity credit is 40% refundable. That means a portion of the credit will be refunded to you even if you don’t owe any federal income tax.
Here’s how it works. Say your American Opportunity credit is $2,500. The refundable portion is $1,000 ($2,500 x 40%). That amount is treated as a payment on your tax return (as if you had the $1,000 withheld from your wages).
The remaining $1,500 ($2,500 x 60%) is a nonrefundable credit that provides a benefit to you only if you owe federal income taxes. If you don’t owe any federal income tax because of deductions and other credits, the entire $1,000 refundable credit counts as a tax overpayment and is refunded to you.
For example, if you owe $1,900 in taxes, the nonrefundable $1,500 portion of the credit is used first to reduce your tax bill to $400. Then the first $400 of the refundable credit is used to lower your tax bill to zero. Finally, the last $600 of the refundable credit is paid to you as a tax refund.
If your federal income tax bill is $4,500, the $1,500 nonrefundable portion of the credit reduces your tax bill to $3,000. Then the $1,000 refundable credit further reduces your tax bill to $2,000.