2009 and 2010 bring a slew of changes to the structure of tax credits and deductions in the Federal Income Tax system. Today I would like to draw attention to the American Opportunity Tax Credit. The American Opportunity Credit expanded and renamed the Hope Credit for tax years 2009 and 2010. The expanded credit increases the total available credit to $2,500 per year for the first four years of post secondary education. This is an increase of $700 over the old Hope Credit. The Hope Credit was also only applicable to the first two years of school. Adding $700 per year and an additional two years to eligibility make the new credit worth up to an additional $6,400.
How do I get the credit?
The American Opportunity Credit offers a credit of 100% on the first $2,000 of tuition, fees and course materials paid during the taxable year plus 25% of the next $2,000. To be eligible for the credit the taxpayer filing married jointly must have modified adjusted gross income of less than $180,000. Between $160,000 and $180,000 a phase-out will apply. Cut the dollar amount in half for single filers. The Hope Credit was completely phased out at $116,000 for a married taxpayer and $58,000 for single.
How does the tax credit work?
A tax credit is a dollar for dollar reduction in total tax in a given year. The American Opportunity Tax Credit is also a refundable tax credit. This is not true for many credits, meaning that if the credit results in an overpayment of tax, up to $1,000 can be refunded directly to you. The credit is available per student.
Keep in mind…
As of today, the American Opportunity Tax Credit is only set to apply for tax years 2009 and 2010. We can only speculate whether it will be extended or revert back to the original Hope Credit. The Hope Credit was available only to those who claimed the student as a dependent on their income taxes regardless of who paid the fees. This leaves “non-custodial” parents out in the cold as far as the credit is concerned. A parent who paid $4,000 of tuition and fees for their child and met the AGI limits would be entitled to a $2,500 credit. If that same parent were divorced and agreed to allow their former spouse to claim the child as dependent for tax purposes; they forfeit the tax credit. It is unclear to me at this time if the dependency requirement remains for the American Opportunity Credit as all published material I have found leaves the question un-answered.
Divorce Financial Planning
Planning for Dependency Exemptions and other tax issues is a regular part of financial planning for divorce. The IRS allows the transfer of dependency exemptions to a “non-custodial” parent via form 8332 but has not allowed a “non-custodial” parent to claim other child related tax credits to date. This makes a conversation on the topic necessary in any case where children are involved. Understanding tax credits and deductions and the planning that can maximize the value to your family is part of the divorce financial planning process. Failing to consider the American Opportunity Tax Credit alone could leave $5,000 per child on the table and potentially more if extended beyond 2010.
Consider the Following Family
Twin sons age 18 are both full-time students. They just started freshman year of college in September of 2009, one at University A, the other at the University B. Parents are currently working through divorce proceedings and plan to split the cost of the children’s undergraduate college education equally.
Assume each dependency exemption is worth $3,650 in 2009, 2010, 2011 and 2012.
Assume the American Opportunity Tax Credit is worth $2,500 per student in 2009 and 2010.
Assume the Lifetime Learning Credit is not valuable to either party because they exceed phase-out limits in 2011 and 2012 and the Hope Credit remains available for the first two years of college only.
Assuming that each parent is in a 28% effective tax rate; the value of the dependency exemption and American Opportunity Tax Credit together over the four year period is $18,176. Failing to negotiate these points in your divorce proceedings leaves this money on the table.
Additional credits and deductions subject to child custody arrangements include the Child Tax Credit, Tuition and Fee Deductions, and Earned Income Credit. I have not considered these in the analysis above.