Wouldn't it be great if there were discount coupons for your taxes? You would just grab the Sunday newspaper, flip to the glossy coupon insert and clip along the dotted line to save big bucks on your next tax bill.
Well, here's some good news: Families with kids in college can, in fact, benefit from this type of discount "coupon." Allow me to introduce you to the new $2,500 American Opportunity Tax Credit.
Compared to a tax deduction (which reduces the amount of income subject to tax), this tax credit is worth much more: It is really like a coupon that reduces, dollar for dollar, the amount of taxes you owe.
How and when can you claim these tax breaks? To answer this question for your specific situation, follow through on these three steps.
Step 1: Break Down the Key Rules
The new American Opportunity Tax Credit is technically an expansion of the old Hope college credit. But with larger potential savings and expanded eligibility requirements, the new credit is a significant improvement.
Here's how it works: Eligible families can claim a tax credit equal to 100% of their first $2,000 of qualified tuition and expenses, and 25% of the next $2,000. Simply put, you'll need $4,000 in eligible expenses to receive the full $2,500 credit.
So what types of expenses can you count? Tuition, books, fees and certain supplies that are required can qualify for an undergraduate student studying at least half-time. Unfortunately, money spent on room and board can't be used.
The great thing about the new rules is that many more families can now qualify—including many who wouldn't have under the old Hope rules. If you're a married couple filing jointly who have modified adjusted gross income up to $160,000 ($80,000 for single filers), then you can claim the full credit for both 2009 and 2010. Beyond that income level, the credit gradually phases out, with those earning up to $180,000 ($90,000 for singles) eligible to claim a partial credit. (The full Hope credit was only available to couples with incomes below $96,000 ($48,000 for singles).
Furthermore, while the old Hope credit could only be claimed for two years, the new American Opportunity credit can be claimed for all four years of undergraduate study.
Better yet, the new credit is also partially refundable—meaning that even if you don't earn enough to pay income taxes, you can still get up to $1,000 back. Put another way, if you qualified for the full $2,500 credit, but only owed $2,000 in income taxes, you wouldn't need to pay any taxes and would also get an additional $500 from the government.
Step 2: Consider the Implications of Separate Returns
If parental income exceeds the above limits, a student may still be able to qualify if he files a separate tax return, earns some income on his own, and pays a portion of college costs (enough to qualify for these credits) out of his own pocket.
The downside of this approach is that the student's parents would no longer be able to claim this child as a dependent on their tax return. You should, therefore, weigh the amount of the student's newfound tax credit against the offsetting impact on the parents' tax return.
Step 3: Be Strategic with Qualified Expenses
Much like eating vegetable crudités and ranch dip on a buffet line, tax rules specify no "double dipping"—you can't use $4,000 of educational expenses to qualify for an American Opportunity credit and then use those same expenses to qualify for another tax benefit (like tax-free treatment on a 529 college savings plan distribution). Therefore, keep track of the specific educational expenses "used up" by each credit.
For more details on any of this, download IRS Publication 970 from www.irs.gov and consult a tax professional.
So what are you waiting for? Although I can’t offer you anything to clip (except perhaps this column), I can offer you something better—a way to trim your taxes due.
The information provided is for informational purposes only and should not be relied on as tax or legal advice. Please discuss your particular situation with your tax advisor.
Known as "America's Scholarship Coach," Ben Kaplan is publisher of the www.CityofCollegeDreams.org website and the winner of two dozen college scholarships worth $90,000. For more details on this topic, visit his Financial Aid information page.
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