The American Opportunity Tax Credit (AOTC) is a partially-refundable tax credit up to $2,500 that helps students cover tuition and college expenses.
What Is the American Opportunity Tax Credit?
The federal government offers two income tax credits to help offset the costs of higher education. They are the American Opportunity Tax Credit (formerly the Hope Scholarship Tax Credit) and the Lifetime Learning Tax Credit (LLC). The AOTC is discussed here.
The AOTC may be claimed for the qualified tuition, fees, and course materials expenses of each eligible student in a taxpayer’s family. The student, or students, must be enrolled:
1. at least half-time in one of the first four years of postsecondary education;
2. for at least one academic period beginning during the relevant tax year; and
3. in a program leading to a degree, certificate, or another recognized educational credential.
The AOTC is a partially-refundable tax credit. A refundable tax credit allows a taxpayer to receive a refund, if the amount of the taxpayer’s tax credit exceeds the taxpayer’s income tax liability. The AOTC is refundable up to a maximum of 40 percent ($1,000) of the maximum tax credit of $2,500.
The AOTC is calculated on qualifying expenses paid during the tax year. The exact amount of the tax credit also depends on:
- a family's adjusted gross income;
- the amount of qualifying tuition, fees, and course materials expenses paid; and
- the amount of certain scholarships and allowances awarded to the student.
Taxpayers can claim more than one AOTC on a tax return, provided that more than one individual (the taxpayer, the spouse, or a dependent) meets the qualifications.
A family may claim both the AOTC and the LLC, as long as the same student is not used as the basis for both credits and the family doesn't exceed the LLC maximum per family.
The AOTC is subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly), and it is not available to married taxpayers who file separate returns. The credit is allowed against the alternative minimum tax. Students who have been convicted of either a federal or state felony drug offense are ineligible for the AOTC.
Who Benefits and How?
The AOTC - originally called the Hope Scholarship Tax Credit - was enacted to help make college more affordable by reducing the cost of higher education relative to income. The credit is a valuable incentive for taxpayers to pursue higher education or to acquire new or enhanced job skills. In this way, the AOTC helps to expand, update, and keep competitive the knowledge and skills of the American workforce.
Federal tax credits for higher education expenses encourage greater participation in higher education. Tax credits are subtracted directly from the amount of income tax a taxpayer owes the federal government.
To claim the AOTC, taxpayers must report qualified expenses - such as tuition and fees - as well as the amount of certain scholarships, grants, and untaxed income used to pay tuition and fees. Universities are required to send information on tuition and fees payments to each taxpayer and to the IRS in the form of a 1098-T statement.
According to a 2016 Congressional Research Service report, “[d]ata confirm that the AOTC primarily benefits middle-income taxpayers, although lower-income taxpayers and upper-middle income taxpayers also receive the credit.”
Proposals for Strengthening the AOTC
AAU has long supported simplification of higher education tax incentives because of the complex rules for claiming them. They are difficult for the average taxpayer to use as effectively as Congress intended. In fact, a 2008 study by the Government Accountability Office (GAO) found that “[s]ome tax filers do not appear to make optimal education-related tax decisions” and that a likely explanation of “these taxpayers’ choices may be the complexity of postsecondary tax provisions, which experts have commonly identified as difficult for tax filers to use.”
Consolidate the AOTC and LLC into a Two-part AOTC
The AOTC and LLC should be consolidated to provide benefits for not only undergraduates but graduate students and life-long learners, many of whom are low-income and need assistance in pursuing additional skill development or the advanced degrees that employers and our economy need. An improved credit should also work well for both traditional and nontraditional students.
The first part of a consolidated tax credit should include the current AOTC, be limited to four years, and be fully or partially refundable for students enrolled at least half-time. The second part of a consolidated credit should consist of a non-refundable credit of $2,000 (like the LLC) that, like the AOTC, would cover 100 percent of the first $2,000 of the AOTC’s eligible expenses. It should also be indexed to inflation.
This proposal would simplify the LLC and also create greater parity for students beyond their first four years of college and lifetime learners. In addition, the AOTC part two would provide a benefit for graduate students who have suffered from policy changes in recent years ending their eligibility for federal subsidized student loans and requiring them to pay higher interest rates.
Fix the AOTC-Pell Grant Interaction
A consolidated AOTC should better coordinate the interaction of the AOTC with the Pell Grant and exclude the Pell Grant from taxable income. Currently, the AOTC eligibility formula sharply limits the size of the tax credit received by needy students at the lowest cost schools. As a result, many of the lowest-income students do not receive any benefit from the current AOTC. Ideally, Pell Grants also should be excluded from taxable income for purposes of a consolidated or improved AOTC.
- IRS Explanation of the American Opportunity Tax Credit
- Congressional Research Service Report “The American Opportunity Tax Credit: Overview, Analysis, and Policy Options”
- IRS Publication 970 Tax Benefits for Education
- GAO Study “Multiple Higher Education Tax Incentives Create Opportunities for Taxpayers to Make Costly Mistakes”