How the American Opportunity Tax Credit Works

The American Opportunity Tax Credit allows students to reduce what they owe in taxes.
The American Opportunity Tax Credit allows students to reduce what they owe in taxes.
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Uncle Sam wants you to learn. Educated citizens make better workers and mean more opportunity for advancements in technology and other fields and an informed society. The problem is that higher education is a little pricey. The federal government tries to make school costs a bit more manageable by offering students low-interest loans, as well as grants and other financial assistance. It also gives students -- or their parents -- the chance to save a little cash come tax time.

The American Opportunity Tax Credit (AOTC) is one of two tax credits available to students and those who claim them as dependents. It allows eligible students to reduce what they owe in taxes by up to $2,500 a year for tuition and related expenses. The AOTC was created by the American Recovery and Reinvestment Act, the legislative response to the 2009 recession. Since then, the credit has been extended, at least through 2019 (tax year 2018) [sources: H&R Block, IRS]. It's similar to the lifetime learning credit, which also covers school costs, but features a number of important differences which we will explain later.

The exact credit amount is 100 percent of the student's first $2,000 in eligible costs and 25 percent of the next $2,000 in expenses. (Hence the total of $2,500.) Eligible taxpayers can seek the credit in four separate years to cover both tuition and expenses like books, supplies and other required course materials. That includes tuition and expenses paid for with a student loan, but not costs covered by scholarships, grants or other nontaxable assistance [sources: IRS, IRS].