What is the American Opportunity Tax Credit?
The American Opportunity Tax Credit (AOTC) is a federal tax credit for qualified education expenses paid for a student for the first four years of higher education. The maximum AOTC credit is $2,500 per eligible student. If your tax owed is reduced to zero after the credit is applied, you can have 40% of the remaining amount of the credit (up to $1,000) refunded to you. The AOTC credit is calculated as follows: 100% of the first $2,000 of qualified education expenses paid and 25% of the next $2,000 of qualified education expenses paid for qualified students.
Who is eligible for the AOTC credit?
The eligibility requirements are as follows:
- A student that is pursuing a degree or other recognized education credential
- The student must be enrolled at least half-time for one academic period within the tax year
- The student has not finished the first four years of higher education at the beginning of the tax year
- The student has not claimed the AOTC for more than 4 tax years
- The student does not have a felony drug conviction at the end of the tax year
How do I claim the American Opportunity Credit?
To claim the AOTC or Lifetime Learning credit the tax law requires a taxpayer (or a dependent) to receive a Form 1098-T, Tuition Statement, from their school by January 31st. This statement helps the tax preparer figure out the amount of your credit.
Is there an income limit for claiming the AOTC?
Yes, there is an income limit for claiming the American Opportunity Credit. To receive the full credit
a single or head of household taxpayer’s modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married filing jointly). If your MAGI is over $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly) you will receive a reduced credit. Once your MAGI is over $90,000 ($180,000 for married filing jointly) you are unable to claim the credit.
What is a 529 investment account?
A 529 plan is a tax-advantaged savings plan that helps to encourage saving for future education costs. A 529 plan has two types of plans: a prepaid tuition plan and an education savings plan. The prepaid tuition plans let savers or account holders purchase units or credits at participating colleges and universities for future tuition. Education savings plans let a saver open an investment account to save for the beneficiary’s future qualified higher education expenses such as tuition, books, supplies, mandatory fees, and room and board. An education savings plan allows for withdrawals at any college or university and sometimes at non-U.S. colleges or universities. Education savings plans can also be used to pay for up to $10,000 per year per beneficiary for tuition at any public, private, or religious elementary or secondary school, which is something the prepaid tuition plans do not allow.
What happens if your child does not go to college but has a 529 plan?
A 529 plan is used for education-related expenses and when money is withdrawn for unrelated education expenses there is a 10% penalty assessed on the money that was taken out, and you will also be responsible for federal and state income tax on the earnings. If your child decides not to go to college, you are able to use their 529 plan to transfer funds to another child or to yourself if you plan on receiving a higher education.
Contributions to a 529 plan
Contributions to 529 plans do not have annual contribution limits, but the contributions are considered completed gifts for federal tax purposes. For the 2022 tax year, the limit for gift contributions is $16,000 per donor. Any excess contributions must be reported to the IRS on Form 709 and will count against the taxpayer’s lifetime estate and gift tax exemption total.
What is a Coverdell Education Savings Account (ESA)?
A Coverdell Education Savings Account is a tax-deferred trust account that was created by the U.S. Government to assist families in funding educational expenses for the beneficiaries of the account. The beneficiaries of this account must be under the age of 18 when the account is created, but the age restriction can be waived for special needs beneficiaries.
Contributions to a Coverdell Education Savings Account and Who Qualifies
The maximum contribution for a Coverdell Education Savings Account per year is $2,000 for any single beneficiary. A Coverdell Education Savings Account is only available to families below a certain income level which is based on their adjusted gross income. The AGI requirements are $95,000 or below for single taxpayers and $190,000 or below for married taxpayers for the full $2,000 contribution limit. The contribution limit is lowered for higher earners and phased out for single taxpayers with AGI of $110,000 or more and for married taxpayers with AGI of $220,000 or more.
How does a Coverdell Education Savings Account work?
A Coverdell Education Savings Account allows families to increase investment earnings through tax-deferrals provided the funds are used for educational purposes. When the contributions are distributed to the beneficiaries they are tax-free as long as it is less than the annual adjusted qualified education expenses. If the distributions from the account are greater than the qualified education expenses, the gains are taxed at the account holder’s rate. Coverdell Education Savings Account funds can be used for primary schools, secondary schools, and higher education.
What happens if your child doesn’t go to college but has a Coverdell Education Savings Account?
If the child does not go to college and they do not use the money in the account by the age of 30 the amount will be distributed to them, and they will be taxed on that amount.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal, or accounting advice. If you have any questions about education credits or tax planning, please do not hesitate to contact us at Lear & Pannepacker.