Improving the American Opportunity Tax Credit

Excerpt from Pub 970

In May 2024 I had the opportunity to participate in the California Lawyers Association Tax Section's DC Delegation. Participants identify a tax rule in need of reform and draft a paper explaining why change is needed and offer proposals for that reform.

My May paper was on modifying and clarifying the American Opportunity Tax Credit (AOTC) which offers up to $10,000 of tax credit (subsidy) to most families for a child (or themselves) in the first four years of college ($2,500 maximum credit for year for up to four years).

The phaseout income levels for the credit are quite high so at least 80% of families qualify.

But there is a bit of unneeded confusion and complexity in the provision including exactly how the "first four years of college" are determined. An example on the IRS website makes it sound like you can select which of the four years of college count which seems out of sync with Code Section 25A (Q&A 16).  But in sync if we are only required to ask if the student has reached "senior" status at the university. This basic issue should not be confusing, but is.

The IRS has an Interactive Tax Assistant tool on its website which can help but I found it might cause some users to give up such as asking if your spouse has an ITIN after answering "single" to the question about whether you are married.

There is also some complex planning possible if a student receives a scholarship, including a Pell Grant, that is partially taxable. One fix to help Pell Grant recipients has been proposed a few times but not enacted is to not require a Pell Grant recipient to reduce AOTC-eligible expenses by the amount of the grant.

For more background and my recommendations for both legislative and administrative improvements, see "Modify and Clarify the American Opportunity Tax Credit," Tax Notes Federal, 9/26/24.

What do you think?

American Opportunity Tax Credit Issues

Over the years, I have heard individuals and tax professionals raise various questions on the operation of the American Opportunity Tax Credit (AOTC at IRC 25A). This is the credit that for the past many years provides up to a $2,500 credit for each of the first four years of higher education at a college or university.  It started in the early 1990s as the Hope Scholarship credit for a lower amount and only the first two years of college.

There are numerous other tax breaks for higher education including an exclusion for scholarships, a limited above-the-line deduction for student loan interest, the Lifetime Learning Credit, an exclusion for interest on education savings bonds, 529 accounts, and more.

Some of the issues I have heard for the AOTC include:

• Do years at a community college count as part of the four years? I believe they do, but what if the student isn't, at least at first, pursuing a degree?
• What are all of the expenses that qualify?
• What if the 1098-T received (and required to claim the credit) is incorrect in terms of the year or amount?
• Why does it only cover college or university programs rather than also trade schools and similar?

I'm working on a paper of these and a few other administrative and legislative issues about the AOTC. If you have questions or issues you've encountered or wondered about, I would greatly appreciate you posting them in a comment here.  Thank you!