Uncle Sam Wants to Help You Pay for College: Tax Tips

To qualify for the American Opportunity Credit a student must be enrolled in a post-secondary education program at an "eligible institution" that leads to a degree, a certificate or another recognized credential at least half-time for one semester during the year. An "eligible institution" is an accredited college, university, vocational school or other accredited institution able to participate in a student aid program administered by the U.S. Department of Education. The student must not have a felony conviction for possession or distribution of a controlled substance.

Only the person claiming the student as a dependent can claim the credit. This can be the student if he/she is not claimed as a dependent by his/her parents or anyone else. It doesn't matter who actually pays the tuition. If the grandparents pay all the student's expenses, but the parents claim the student as a dependent, the parents get the credit.

The credit is available if the eligible expenses are paid using money from a student loan or any other borrowing.

Eligible expenses must be reduced by any tax-free scholarships or grants, employer-provided education assistance, veterans' assistance and any other tax-free payments or reimbursements. All such payments are applied first toward tuition, fees and course materials. They are not allocated between eligible expenses and room and board. If the student has $10,000 in eligible expenses and $4,000 in room and board expenses and received a scholarship for $7,500, only $2,500 in expenses can be used to calculate the credit.

Unfortunately, many parents with dependents attending college will be unable to receive any tax benefit from the American Opportunity Credit due to the AGI limitations. However, there is hope, thanks to IRS Field Service Advice FSA 200236001. While the AOC is only available to the person who claims the student as a dependent, there is a way for a dependent student to receive a tax benefit from the credit on his/her return.

James, son of John and Jane, is a 20-year-old unmarried full-time college student in his junior year. He had net taxable income from a part-time job. John and Jane are entitled to claim James as a dependent on their Form 1040.

James' eligible education expenses for the year exceeds the $4,000 minimum needed to qualify for the maximum credit, but John and Jane's Adjusted Gross Income is $185,000.

James' tax liability is more than the amount of federal and state tax savings John and Jane would realize from claiming James as a dependent.