The recently enacted 2012 Taxpayer Relief Act includes a 5-year extension (through 2017) of the American Opportunity tax credit for college costs. Added to the tax code in 2009 as a temporary replacement of the previous Hope tax credit, the American Opportunity credit both increased the tax relief available for students from middle-income families and also extended relief for the first time to students from lower-income families. Now that the American Opportunity tax credit has been extended for five years, it might be a good time to review the tax benefits available under that credit, with an eye to how it compares with the Hope credit, which would have been in effect over the next two years had the American Opportunity credit not been extended.
- Families with a family member in college can benefit from a tax credit for tuition and fees. From a taxpayer's point of view, a credit is almost always preferable to a deduction, because a credit reduces taxes owed, while a deduction only reduces taxable income. The maximum amount of the American Opportunity tax credit is $2,500 (up from a maximum credit of $1,800 under the Hope credit). The credit is 100% of the fist $2,000 of qualifying expenses and 25% of the next $2,000, so the maximum credit of $2,500 is reached when a student has qualifying expenses of $4,000 or more.
- While the Hope credit was only available for the fist two years of undergraduate education, the American Opportunity tax credit is available for up to four years.
- Under the Hope credit, qualifying expenses were narrowly defined to include just tuition and fees required for the student's enrollment. Textbooks were excluded, despite their escalating cost in recent years. The American Opportunity tax credit expands the list of qualifying expenses to include textbooks.
- The Hope credit was nonrefundable, i.e., it could reduce your regular tax bill to zero but could not result in a refund. This meant that if a family didn't owe any taxes it couldn't benefit form the credit, which prompted critics to argue that the credit was thus denied to the very families most in need of help affording college. The American Opportunity tax credit addresses this criticism to a degree by providing that 40% of the credit is refundable. This means that someone who has at least $4,000 in qualified expenses and who would thus qualify for the maximum credit of $2,500, but who has no tax liability to offset that credit against, would qualify for a $1,000 (40% of $2,500) refund from the government.
- The Hope credit was not available to someone with higher than moderate income. Under the credit's “phaseout” provision, taxpayers with adjusted gross income (AGI) over $50,000 (for 2009) saw their credits reduced, and the credit was completely eliminated for AGIs over $60,000 (twice those amounts for joint filers). Under the American Opportunity tax credit, taxpayers with somewhat higher incomes can qualify, as the phaseout of the credit begins at AGI in excess of $80,000 ($160,000 for joint filers).