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American Opportunity Tax Credit (AOTC): Definition and Benefits

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American Opportunity Tax Credit (AOTC): Definition and Benefits

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What Is the American Opportunity Tax Credit (AOTC)?

The American Opportunity Tax Credit (AOTC) is a tax credit for qualified education expenses associated with the first four years of a student’s postsecondary education. The maximum annual credit is $2,500 per eligible student. The student, someone claiming the student as a dependent, or a spouse making postsecondary education payments can claim the AOTC on their tax return.

Key Takeaways

  • The American Opportunity Tax Credit (AOTC) helps offset the costs of postsecondary education for students or their parents (if the student is a dependent).
  • The AOTC allows an annual $2,500 tax credit for qualified tuition expenses, school fees, and course materials.
  • Room and board, medical costs, transportation, and insurance do not qualify, nor do qualified expenses paid for with 529 plan funds.
  • To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 if married filing jointly).

Understanding the American Opportunity Tax Credit (AOTC)

With the AOTC, a household with a qualifying student can receive a maximum $2,500 tax credit per year for the first four years of higher education. Parents claiming a dependent child who is a full-time student ages 19 to 24 can claim an additional $500 Child Tax Credit.

The AOTC helps with educational costs such as tuition and other expenses related to a student’s coursework. Eligible students (or their parents) can claim 100% of the first $2,000 spent on school expenses and 25% of the next $2,000. This comes out to a maximum credit of $2,500: (100% × $2,000) + (25% × $2,000).

The American Opportunity Tax Credit is partially refundable, which means that it could provide a refund even if your tax liability is $0.

In general, tax credits are refundable, nonrefundable, or partially refundable. Up to $1,000 (40%) of the AOTC is refundable, making it a partially refundable tax credit. So, if the credit brings your tax liability to $0, you can receive 40% of your eligible credit (up to $1,000) as a refund.

AOTC Eligibility Requirements

Like other tax credits, you must meet specific eligibility requirements to claim the AOTC.

Who Can Claim the AOTC?

To claim the AOTC on your tax return, you must meet all three of these requirements:

  • You pay qualified education expenses for higher education.
  • You pay the education expenses for an eligible student.
  • The eligible student is either you, your spouse, or a dependent whom you claim on your tax return.

Additionally, you must receive Internal Revenue Service (IRS) Form 1098-T to claim the credit. Here’s an example of a completed form:

Source: Internal Revenue Service

Which Students Qualify for the AOTC?

A student is eligible for the AOTC only if they meet certain requirements. Specifically, the student must:

  • Be taking courses toward a degree or some other recognized education qualification
  • Be enrolled at least part 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
  • Not have a felony drug conviction at the end of the tax year

Academic periods can be quarters, trimesters, semesters, or summer school sessions. If the school doesn’t have academic terms, you can treat the payment period as an academic period.

Which Expenses Qualify for the AOTC?

For the purposes of the AOTC, qualified education expenses include tuition and some related costs required for attending an eligible educational institution. An eligible educational institution is any accredited public, nonprofit, or private college, university, vocational school, or other postsecondary educational institution. Related expenses include:

  • Student activity fees paid to the school as a condition of enrollment or attendance
  • Books, supplies, and equipment needed for classes, whether or not you buy them from the school

Insurance, medical expenses (including student health fees), room and board, transportation, and living expenses do not count as qualified education expenses.

You can pay for qualified education expenses with student loans. However, you can’t claim the credit if you paid for expenses with scholarships, grants, employer-provided assistance, or funds from a 529 savings plan.

What Are the Income Limits for the AOTC?

To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 if married filing jointly). The credit begins to phase out above these limits and disappears entirely if your MAGI is above $90,000 ($180,000 for married filing jointly).

Income Limits for the American Opportunity Tax Credit
  Single Married Filing Jointly
Full Credit $80,000 or less $160,000 or less
Partial Credit More than $80,000 but less than $90,000 More than $160,000 but less than $180,000
No Credit More than $90,000 More than $180,000
Source: Internal Revenue Service

AOTC vs. Lifetime Learning Credit

The AOTC and the Lifetime Learning Credit (LLC) are popular tax breaks that people with educational expenses can claim on their annual tax returns. While similar, the LLC and the AOTC differ in several ways.

With the LLC, you can claim up to 20% of the first $10,000 of qualifying expenses ($2,000). The LLC is not limited to students pursuing a degree or studying at least part time. Instead, it covers a broader group of students—including part-time, full-time, undergraduate, graduate, and courses for skill development. Finally, the LLC is nonrefundable, meaning that once your tax bill hits zero, you won’t receive a refund on any credit balance.

American Opportunity Tax Credit (AOTC) vs. Lifetime Learning Credit (LLC)
 Criteria AOTC LLC
Maximum Benefit Up to $2,500 per student Up to $2,000 per return
Credit Type Partially refundable (40% of credit) Nonrefundable
MAGI Limit (Single) $90,000 $80,000
MAGI Limit (Married Filing Jointly) $180,000 $160,000
# of Tax Years Available Four per student Unlimited
Program Requirement Degree seeking N/A
Course Load At least half time for at least one academic period At least one course
Qualified Expenses Tuition, required fees, and course materials Tuition and fees
Felony Drug Conviction Not allowed N/A
Source: Internal Revenue Service

If you’re eligible for both the AOTC and the LLC, be sure to assess your individual situation to determine which tax credit provides the greater benefit. The partial refundability of the AOTC can be an important factor. Of course, some taxpayers may only qualify for the LLC, making the decision easy.

You can claim the AOTC and the LLC (as well as the deduction for tuition and fees) on the same tax return—but not for the same student or the same qualified expenses.

Other Tax Breaks for Education

Federal and state governments support higher education expenses through various tax credits, tax deductions, and tax-advantaged savings plans. Each of these programs can help lower your income tax liability and make education more affordable. Beyond the AOTC and the LLC, be sure to claim any education-related tax deductions for which you may be eligible, including those for:

Savings plans can also help with higher education expenses. These are tax-advantaged accounts that allow you to save—and pay for—education expenses. Two popular programs include:

Thanks to the Tax Cuts and Jobs Act, you can now use up to $10,000 of 529 plan distributions to pay for K–12 costs per beneficiary each year. Previously, you could use the funds only for college and other postsecondary education expenses.

AOTC Example

Rosa is a full-time undergraduate college student at a four-year institution. She also works for a law firm. Her parents have a substantial 529 savings account in place, but it doesn’t cover all of Rosa’s expenses. Rosa also has a student loan with deferred payments and interest until after graduation.

Rosa and her family pay her tuition with student loans and use funds from a 529 plan to cover room and board. Rosa receives her annual 1098-T statement and, since she is working, she plans to take the AOTC herself. She is eligible for both the AOTC and the LLC, but she chooses the AOTC because it provides a larger credit and is partially refundable.

Rosa paid her tuition with a student loan, which is allowable for the AOTC. The AOTC helps alleviate any tax that she owes and she also gets a partial refund. Rosa doesn’t owe anything on her loans until after she graduates. The money distributed from the 529 was tax-free because it was used for room and board, which is a qualified 529 expense.

How Do I Claim the American Opportunity Tax Credit (AOTC)?

To claim the American Opportunity Tax Credit (AOTC), complete Form 8863 and submit it with your Form 1040 or 1040-SR when filing your annual income tax return. Enter the nonrefundable part of the credit on Schedule 3 of your 1040 or 1040-SR, line 3. The refundable portion of the credit goes on line 29 of the 1040 or 1040-SR.

Can I Claim the AOTC and the Lifetime Learning Credit?

Yes. You can claim the AOTC and the Lifetime Learning Credit (LLC) on the same tax return. However, you can’t claim both credits for the same student or the same expenses during a single tax year.

Can I Claim the AOTC if I Get a Grant?

Yes. However, you need to subtract that amount from your qualified education expenses before claiming the tax credit. So, if you have $5,000 in costs and a $4,000 grant, you would be able to claim $1,000 of qualified education expenses for the AOTC. For the purposes of the AOTC, grants include:

  • Tax-free parts of scholarships and fellowships
  • Pell Grants and other need-based education grants
  • Employer-provided assistance
  • Veterans’ educational assistance
  • Any other tax-free payments that you receive for educational aid (excluding gifts and inheritances)

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Additional Child Tax Credit (ACTC): Definition and Who Qualifies

Written by admin. Posted in A, Financial Terms Dictionary

Additional Child Tax Credit (ACTC): Definition and Who Qualifies

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What Is the Additional Child Tax Credit?

The additional child tax credit was the refundable portion of the child tax credit. It could be claimed by families who owed the IRS less than their qualified child tax credit amount. Since the child tax credit was non-refundable, the additional child tax credit refunded the unused portion of the child tax credit to the taxpayer. This provision was eliminated from 2018 to 2025 by the Tax Cuts and Jobs Act (TCJA).

However, under the TCJA, the child tax credit includes some provisions for refundable credits. In addition, on March 11, 2021, President Biden’s American Rescue Plan was voted into law and made child tax credits fully refundable in 2021.

Key Takeaways

  • The additional child tax credit was the refundable portion of the child tax credit.
  • It could be claimed by families who owed the IRS less than their qualified child tax credit amount.
  • The additional child tax credit was eliminated for 2018 to 2025 by the Tax Cuts and Jobs Act,
  • Child tax credits for 2021, however, were made fully refundable as part of the American Rescue Plan.
  • For 2021, advance child tax credits could be claimed via monthly payments in the amount of half of their total child tax credit. The second half can be claimed by those eligible on their 2021 tax returns.

Tax Deductions Vs. Tax Credits

Understanding the Additional Child Tax Credit

A tax credit is a benefit given to eligible taxpayers to help reduce their tax liabilities. If Susan’s tax bill is $5,550 but she qualifies for a $2,500 tax credit, she will only have to pay $3,050. Some tax credits are refundable, meaning that if the tax credit amounts to more than what is owed as tax, the individual will receive a refund. If Susan’s tax credit is actually $6,050 and is refundable, she will be given a check for $6,050 – $5,550 = $500.

Depending on what tax group a taxpayer falls in, they may be eligible to claim a tax credit. For example, taxpayers with children may qualify for the child tax credit which helps to offset the costs of raising kids.

For the 2022 through 2025 tax year, the child tax credit allows eligible tax filers to reduce their tax liability by up to $2,000 per child. To be eligible for the child tax credit, the child or dependent must:

  • Be 16 years or younger by the end of the tax year
  • Be a U.S. citizen, national, or resident alien
  • Have lived with the taxpayer for more than half of the tax year
  • Be claimed as a dependent on the federal tax return
  • Not have provided more than half of their own financial support
  • Have a Social Security number

Child Tax Credit vs. Additional Child Tax Credit

Previously, the child tax credit was non-refundable, which means the credit could reduce a taxpayer’s bill to zero, but any excess from the credit would not be refunded. Families who wanted to keep the unused portion of the child tax credit could go the route of another available tax credit called the additional child tax credit.

This credit was a refundable tax credit that families could qualify for if they already qualified for the non-refundable child tax credit. The additional child tax credit was ideal for families who owed less than the child tax credit and wanted to receive a refund for the surplus credit.

While the additional child tax credit was eliminated in 2018 under the Tax Cuts and Jobs Act (TCJA), up to $1,400 of the $2,000 child tax credit can be refundable for each qualifying child if certain conditions are met. For example, a taxpayer needs to earn more than $2,500 for the tax year to qualify for any refund. To claim a refund, filers must complete Schedule 8812.

The American Rescue Plan created major changes to the child tax credit for 2021. The maximum credit rose to $3,000 (children up to 17) or $3,600 (children younger than six). Qualifying families started receiving monthly checks (half of the full credit) in July 2021. The credit also became fully refundable in 2021, and families may claim the second half of the credit on their 2021 tax return. This child-related tax benefit begins to phase out for individual filers with children who earn more than $75,000 and joint filers earning more than $150,000.

The additional child tax credit in its previous form was eliminated from 2018 to 2025 by the Tax Cuts and Jobs Act (TCJA).

Example of the Additional Child Tax Credit

Before the TCJA, the IRS allowed families with an annual income of more than $3,000 to claim a refund using the additional child tax credit. The tax credit depended on how much the taxpayer earned and was calculated by taking 15% of the taxpayer’s taxable earned income over $3,000 up to the maximum amount of the credit, which was then $1,000 per child. The total amount above $3,000 (subject to annual adjustments for inflation) was refundable.

For example, a taxpayer with two dependents qualifies for the child tax credit. Their earned income is $28,000, which means income over $3,000 is $25,000. Since 15% x $25,000 = $3,750 is greater than the maximum credit of $2,000 for two kids, they would have received the full portion of any unused credit.

So if the taxpayer received an $800 child tax credit, they would be refunded a $1,200 Additional child tax credit. However, if the taxable earned income was $12,000 instead, 15% of this amount over $3,000 is 15% x $9,000 = $1,350. Because the refundable portion of the credit cannot exceed 15% of earned income above $3,000, the taxpayer would receive a maximum refund of $1,350, not $2,000.

Taxpayers who were residents of Puerto Rico with income below $3,000 were eligible if they had at least three qualifying dependents and paid Social Security tax in excess of the amount of their earned-income credit for the year.

What Is the Difference Between Child Tax Credit and Additional Child Tax Credit?

Under President Biden’s 2021 American Rescue Plan, the child tax credit offers a maximum credit of $3,600 (younger than six years of age) and $3,000 (over age six and up to age 17) to those families who meet eligibility requirements. The additional child tax credit (up to $2,000 per child) was eliminated in 2018 under the Tax Cuts and Jobs Act (TCJA).

Is the New Child Tax Credit for 2020 or 2021?

President Biden’s new child tax credit is based on 2020 tax returns and will be used when you file 2021 taxes in April 2022. The changes to the child tax credit apply (as of July 2021) for the tax year 2021 only, unless they are extended.

Who Qualifies for the Additional Child Tax Credit?

The additional child tax credit was eliminated in 2018, so no one at present qualifies for the additional child tax credit. However, the full new child tax credit is offered to parents (who file jointly) who make up to $150,000 a year.

Are There Additional Requirements for the 2021 Child Tax Credit?

To qualify for advanced payments for the 2021 tax year to receive the Economic Impact Payment, had a main home in the U.S. for more than half the year (or file a joint return with a spouse who has a main home in the United States for more than half the year), have a qualifying child who is under age 18 at the end of 2021 and who has a valid Social Security number, and made less than certain income limits.

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