What You Need to Know about the American Tax Credit

If you’re thinking about heading to school or if you’re sending a child off to college, you need to know about the American opportunity tax credit. This credit is good for students who pay taxes and can help them to supplement the high cost of a college education. The credit reduces the taxes owed based on the amount of money spent So, the more one spends on college, the higher the credit.

Eligibility Requirements

As with most credits, there are strict eligibility requirements that must be met in order to receive this credit. They include:

l  The student must not have completed four years of schooling.

l  The student must be enrolled in college for at least one semester during the tax year.

l  The student must meet the college’s eligibility requirements for part-time enrollment.

l  The program in which the student is enrolled must end in a degree or certificate.

l  The student must not have ever been convicted of a drug related crime.

l  The person applying for the credit must be paying some or all of the educational tuition and fees.

l  The student must be enrolled in a qualifying college or post-secondary school.

The American Opportunity Credit and Financial Aid

Most students will receive some type of financial aid to help fund their education. This may include loans, scholarships, grants, and aid offered by the institution itself. The good news is that any borrowed funds can be counted toward the credit since they will eventually have to be repaid. However, aid that does not have to be repaid does not count toward the credit.

Dependents

Each eligible student is entitled to receive one tax credit and no more. For parents who are claiming the credit on behalf of dependent’s expenses, the same credit must be used for both dependents.

Obviously, there are a lot of rules and requirements for obtaining this tax credit. However, the credit is substantial and well worth the effort put in. While it is possible to fill out the tax credit forms on one’s own, most people find it a lot easier to do with the help of a qualified accountant. 

Investing in the Future

Parents generally don’t have to be convinced of the value of a college education for their children. Studies show that college graduates not only earn more but are healthier, more satisfied with their jobs, and more likely to remain employed during tough economic times.¹

But paying for college becomes more challenging every year. Over the last decade, undergraduate in-state tuition and fees at four-year public colleges and universities rose at a 5.6% average annual rate above the rate of general inflation. For the 2011–12 academic year, the average cost of tuition, fees, room, and board reached $17,131.²

Private institutions are even more expensive, although their costs are rising at a somewhat slower pace. For the 2011–12 academic year, the average cost for tuition, fees, room, and board was $38,589 at nonprofit four-year colleges and universities.³

A Tax-Advantaged Savings Plan

As with saving for retirement, the key to saving for a college education is to develop a strategy and make regular contributions. One helpful savings vehicle is a Section 529 plan — a state-sponsored or college-sponsored program designed to help families save for future higher-education costs. Each plan has its own rules and restrictions, which can change at any time.

The money in a 529 savings plan accumulates on a tax-deferred basis and can be withdrawn free of federal income tax as long as it is used for qualified education expenses at accredited post-secondary schools, such as colleges, universities, community colleges, and certain technical schools. Qualified expenses include tuition, fees, room and board, books, and other supplies. Section 529 plans feature high contribution limits (set by each state), and there are no income restrictions for donors.

As with other investments, there are generally fees and expenses associated with participation in a 529 savings plan. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. The tax implications of a 529 plan should be discussed with your legal and/or tax advisors because they can vary significantly from state to state. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents and taxpayers.

A college education could be an important investment in the future. If you anticipate paying for college, you might develop your savings strategy sooner rather than later.

Before investing in a 529 plan, please consider the investment objectives, risks, charges, and expenses carefully. The official disclosure statements and applicable prospectuses — which contain this and other information about the investment options, underlying investments, and the investment company — can be obtained from your financial professional. You should read this material carefully before investing.

1–3) The College Board, 2010–2011

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent Naperville professional financial and education advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright © 2012 Emerald Connect, Inc.

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