The credit is available if the eligible expenses are paid using money from a student loan or any other borrowing.
Eligible expenses must be reduced by any tax-free scholarships or grants, employer-provided education assistance, veterans' assistance and any other tax-free payments or reimbursements. All such payments are applied first toward tuition, fees and course materials. They are not allocated between eligible expenses and room and board. If the student has $10,000 in eligible expenses and $4,000 in room and board expenses and received a scholarship for $7,500, only $2,500 in expenses can be used to calculate the credit.
Unfortunately, many parents with dependents attending college will be unable to receive any tax benefit from the American Opportunity Credit due to the AGI limitations. However, there is hope, thanks to IRS Field Service Advice FSA 200236001. While the AOC is only available to the person who claims the student as a dependent, there is a way for a dependent student to receive a tax benefit from the credit on his/her return.
James, son of John and Jane, is a 20-year-old unmarried full-time college student in his junior year. He had net taxable income from a part-time job. John and Jane are entitled to claim James as a dependent on their Form 1040.
James' eligible education expenses for the year exceeds the $4,000 minimum needed to qualify for the maximum credit, but John and Jane's Adjusted Gross Income is $185,000.
James' tax liability is more than the amount of federal and state tax savings John and Jane would realize from claiming James as a dependent.
John and Jane could, although entitled to, elect not to claim James as a dependent on their 1040. James cannot claim an exemption for himself because his parents could have done so, but he can claim the American Opportunity Credit on his return.
James is not eligible for the refundable portion of the credit. None of the American Opportunity Credit is refundable if you are under age 18 (or a student under age 24 and your earned income was less than one-half of your support), at least one of your parents was alive at the end of the tax year, and you are not filing a joint return.
James can only claim a credit against actual tax liability. If his tax liability is $500 his credit is limited to $500. If his tax liability is $2,800 he can claim the full $2,500 credit. If the amount of James' taxable income can be controlled it would be good to make sure James earns at least enough to generate a tax liability that assures he will be able to take full advantage of the credit.
As I told you earlier, the American Opportunity Credit is only available to undergraduate students. For 2012, graduate students, or their parents, can claim a Lifetime Learning Credit or, if it is extended by Congress, an above-the-line deduction for tuition and fees.
--By Robert Flach
Robert Flach has more than 40 years of experience as a tax professional and also blogs as
The Wandering Tax Pro