The American Opportunity Tax Credit and the Lifetime Learning Credit are federal tax credits that allow students or their parents to deduct as much as $2,500 or $2,000 from their annual tax bill for the education of an undergraduate, graduate or non-degree or vocational student. The exact credit the taxpayer ultimately receives depends on the filer's income and tax liability. The costs they can deduct, however, include tuition payments, school fees and the cost of books and other supplies.
In addition to reducing a student's financial burden when earning a degree or acquiring a skill, the tax credit gives the children of lower- and moderate-income families a shot at earning a college degree or acquiring a practical skill. To claim the tax credit, the taxpayer completes IRS Form 8863 and submits it to the Agency along with Form 104o or 1040-SR.
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What Is the American Opportunity Tax Credit?
The American Opportunity Tax Credit is unlike a tax deduction in that the former reduces the taxpayer's tax liability, while the latter reduces the taxpayer's taxable income. The precise value of a tax credit depends on the nature of the credit itself and the taxpayer's situation.
In any event, by claiming the 8863 qualified expense credit via the American Opportunity Tax Credit or the Lifetime Learning Tax Credit, the taxpayer reduces their federal tax liability. The 8863 tax credit allows a taxpayer to reduce, dollar for dollar, tax liability, rather than just taxable income.
Tax Deduction Vs. Tax Credit
Because a tax credit reduces a tax liability dollar for dollar up to a stipulated amount, such as that specified in the 26 U.S. Code 25A, American Opportunity and Lifetime Learning Credits, the tax credit potentially reduces a tax liability more so than does a tax deduction. The reason being that a tax deduction reduces a taxpayer's tax liability according to the individual's marginal tax rate, which is the tax rate an individual pays on each additional dollar of income.
For example, for a taxpayer in the 22 percent tax bracket, a tax deduction saves 22 cents for every marginal tax dollar that the tax deduction allows. In contrast, a tax credit, such as that granted by the American Opportunity Tax Credit, reduces the taxpayer's liability by each full dollar the tax credit allows.
Read more: How to Calculate Education Credits
American Opportunity Tax Credit
The American Opportunity Credit (AOC) decreases the tax bill of students or their parents by as much as $2,500 if the student spends $2,500 or more in the pursuit of an undergraduate degree. In this event, the taxpayer who claims the credit – the undergraduate or a parent – claims the first $2,000 of the student's college expenses, including school fees, books, supplies and tuition. The taxpayer can claim another 25 percent of other education-related costs up to $2,000, or $500.
The AOC decreases the tax burden of a student or a parent who finances the education of the undergraduate for as many as four years, the time typically allotted to an undergraduate program. That tax payer, whether the student or a parent, is allowed to claim the tax credit of up to $2,500 for each one of the four years. For the student's parent to claim the tax credit, the parent must list the student as a dependent on their tax return.
Read more: Education Credit Vs. Tuition Deduction
Lifetime Learning Credit
The Lifetime Learning Credit (LLC) lessens the financial burden for a student or a parent who pays for the education or advanced training of an undergraduate, graduate or non-degree or vocational student. The taxpayer can claim the tax credit each year that the dependent student enrolls in a course to enhance their skills. For the student's parent to claim the tax credit, the parent must claim the student as a dependent on their federal tax return.
When claiming the Lifetime Learning Credit (LLC), the student or their parent decreases the tax bill by as much as $2,000, or 20 percent of the first $10,000 spent on school tuition, fees and books or supplies that the student is required to purchase from the school as a condition of enrollment. Living and transportation expenses are excluded.
A taxpayer can claim both the American Opportunity Tax Credit and the Lifetime Learning Credit for a dependent student's education assuming the taxpayer claims the two tax credits in different years or for different students.