It’s the summer before your rising college freshman leaves home for his or her college adventure, and you’ve just received the first bill. Thankfully, you’ve been diligent to sock away funds for your child’s tuition in a tax-advantaged college savings account, such as a 529 plan. Years before, you thought ahead to this day, and set aside funds that grew tax-deferred that can now be withdrawn tax-free for qualified education expenses. That’s great! But, before you make that withdraw, there’s one more thing you may want to consider:
The American Opportunity Credit
Before using your 529 plan on every dollar of that college bill, you may want to see if you’re eligible for certain education tax credits. While there are several different tax deductions and credits out there, for today I’ll just focus on the most advantageous and widely available: the American Opportunity Credit. It allows parents to spend $4,000 “out of pocket” (including by withdrawing funds from a custodial account or by taking out loans) and get a $2,500 tax credit back. (Remember, a tax credit is different than a tax deduction. While a tax deduction “only” reduces your tax bill by your income tax bracket, a credit offers a straight dollar-for-dollar elimination of taxes. Therefore, a tax credit is generally 3-4 times more valuable than a deduction.)
But this tax credit is only available if the college expenses were not paid through withdrawals from a 529 plan.
A lot of folks aren’t familiar with this credit, because their income is too high. Married households making more than $180,000 in income (technically, modified AGI) will not be eligible, and for singles, the limit is $90,000. So be sure to check into that first. Also, it’s important to note that currently the American Opportunity credit is scheduled to continue through 2017, but its fate beyond that is uncertain.
To learn more, see this article from Morningstar.