If you've got children in college, you could be eligible for a valuable tax credit when you file your taxes this year.
The American Opportunity Tax Credit could knock $2,500 off your tax bill for your child's college expenses. If you have two students in school, you may be able to claim a maximum credit of $5,000.
Taxpayers can claim 100 percent of the first $2,000 they spend on qualified college expenses for a student and 25 percent on the next $2,000 spent. Eligible expenses include tuition, fees, textbooks and supplies. Room and board charges do not qualify for the credit.
To qualify for this credit, the modified adjusted gross income of a parent filing as a single taxpayer must not exceed $90,000, or $180,000 for a married couple filing jointly.
While all this sounds straightforward, qualifying for the credit is trickier for parents who are tapping into a 529 college savings account to cover costs. The $4,000 worth of college expenses that you would use to capture the maximum American Opportunity Tax Credit can't come from a 529 plan.
The reason why the qualifying money for the tax credit can't originate from a 529 plan is because these accounts also provide a federal tax benefit. When parents withdraw money from a 529 plan for college expenses, this money is sheltered from federal taxes. The federal government doesn't want you claiming more than one tax benefit on a single pot of money. In other words, you can't double dip when claiming college tax benefits.
Mark Kantrowitz, a nationally recognized financial aid expert and the publisher of Edvisors Network, advises families to reserve $4,000 in tuition and textbook expenses each year to be paid with cash or student loans to qualify for the maximum tax credit. Parents can rely on scholarships and 529 plan proceeds to pay for the remaining expenses.
Kantrowitz and David Levy, the former financial aid director at California Institute of Technology, who is an associate editor at Edvisors Network, has created a valuable and free online guide to college tax credits and deductions that includes advice about which ones to use. You can also find information by reading IRS Publication 970: Tax Benefits for Education.