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

John and Jane could, although entitled to, elect not to claim James as a dependent on their 1040. James cannot claim an exemption for himself because his parents could have done so, but he can claim the American Opportunity Credit on his return.

James is not eligible for the refundable portion of the credit. None of the American Opportunity Credit is refundable if you are under age 18 (or a student under age 24 and your earned income was less than one-half of your support), at least one of your parents was alive at the end of the tax year, and you are not filing a joint return.

James can only claim a credit against actual tax liability. If his tax liability is $500 his credit is limited to $500. If his tax liability is $2,800 he can claim the full $2,500 credit. If the amount of James' taxable income can be controlled it would be good to make sure James earns at least enough to generate a tax liability that assures he will be able to take full advantage of the credit.

As I told you earlier, the American Opportunity Credit is only available to undergraduate students. For 2012, graduate students, or their parents, can claim a Lifetime Learning Credit or, if it is extended by Congress, an above-the-line deduction for tuition and fees.

--By Robert Flach

Robert Flach has more than 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.