Tuesday, June 9, 2015

Coordinating 529 Plan Withdrawals With The American Opportunity Tax Credit

FROM FORBES.COM

The American Opportunity Tax Credit reduces your federal tax bill dollar-for-dollar by up to $2,500 per year for each eligible college student for whom you pay qualified tuition expenses. It can be claimed on behalf of an undergraduate for four years—that’s a $10,000 tax subsidy, over four years. And if you have more than one child in college at the same time, you can claim for each eligible child. This break had been set to expire at the end of 2012, but the fiscal cliff deal extended it for tax years 2013-2017.
American Opportunity Tax Credit Is Worth $2,500
The AOTC is worth up to $2,500 per student each year for four academic years (extended through the 2017 tax year). But families who earn too much can’t claim the credit. The income phase-out for claiming the AOTC is $160,000 – $180,000 of modified adjusted gross income on joint tax returns ($80,000 – $90,000 for single tax filers and head of household). The amount of the credit is calculated as 100% of the first $2,000 in qualified tuition and fees costs paid, plus 25% of the next $2,000 paid for such fees. For lower income taxpayers who don’t owe $2,500 in tax, up to $1,000 of the credit is refundable. (The credit is not refundable on a dependent child’s return).
Which College Expenses Count?
You use IRS form 8863 (get the form and instructions here) to claim the American Opportunity Tax Credit, which is based on qualified college expenses that you pay for yourself, your spouse or a dependent for whom you claim an exemption on your tax return.
According to IRS Publication 970, qualified education expenses are tuition and related expenses required for enrollment or attendance at an eligible educational institution.
An eligible educational institution is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, non-profit, and proprietary (privately owned profit-making) post-secondary institutions. The credit cannot be claimed for college credits taken under dual enrollment programs, where high school students are simultaneously enrolled in college courses. The reason for this is because, according to the Department of Education, high school students are not technically enrolled in a degree-granting program because they do not yet have a college diploma, even though they are earning college credits. It doesn’t make any sense, but that is the rule.
Related expenses are student-activity fees and expenses for course-related books, supplies, and equipment that are required as a condition of enrollment or attendance. The amount of qualified educational expenses that can be used in calculating these tax credits is reduced if you pay for the qualified expenses with certain tax-free funds. They include:
• Tax-free portions of scholarships and fellowships
• Pell grants
• Employer-provided educational assistance (section 127 tuition reimbursement plan)
• Veterans’ educational assistance
• Any other tax-free payments received as educational assistance
Claiming The AOTC Takes Coordination
It is very important to remember that you cannot claim any of the college tax credits, including the AOTC, based on expenses that were used to calculate the tax-free portion of a distribution from a 529 college savings or prepaid plan, or a Coverdell Education Savings Account (ESA). The AOTC may be claimed in the same year that a tax-free distribution is made as long as the same expenses are not used to calculate the tax-free distribution AND the American Opportunity Tax Credit.
For example, if you take $12,000 out of a 529 college savings plan to pay for tuition you cannot use that $12,000 of tuition expenses to claim the American Opportunity Tax Credit also. This coordination of benefits provision is exactly why it helps to have a tax preparer who understands education funding so that you can make the most of the benefits that you qualify for.