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2010 Budget Tax Proposal

Make Permanent the American Opportunity Tax Credit

The economic stimulus act (“American Recovery and Reinvestment Act of 2009”) established for two years the “American Opportunity” tax credit (AOTC) as a replacement for the Hope credit. The president proposes to make the credit permanent and index for inflation both the maximum expenditures eligible for the credit and the income thresholds above which the credit phases out.

The AOTC is a partially refundable tax credit equal to 100 percent of the first $2,000 plus 25 percent of the next $2,000 (both values indexed for inflation) spent on tuition, fees, and course materials during each of the first four years of postsecondary education (double the two years allowed for the Hope credit) for students attending school at least half time. The maximum credit would thus be $2,500 a year. As was the case for the Hope credit, taxpayers could not claim the credit for any expenses paid using funds from other tax-preferred vehicles such as 529 plans and Coverdell Savings Accounts, nor could they use more than one of the AOTC, the lifetime learning credit, and the deduction for tuition expenses for a student in a given year.

Forty percent of the AOTC is refundable and thus available to households with little or no tax liability. The maximum amount of refundable credit is thus $1,000, which would be indexed for inflation under the president's proposal.

The credit phases out evenly for married couples filing joint tax returns with income between $160,000 and $180,000 and for others with income between $80,000 and $90,000. Couples with income above $180,000 and others with income above $90,000 may not claim the credit. The president proposes to index the phaseout thresholds for inflation.

The larger, refundable credit would extend educational assistance to low-income students, making it easier for them to afford college and thus encouraging attendance, but the credit’s phaseout would boost marginal tax rates for affected taxpayers. Because most students would qualify for the credit, colleges might react by raising tuition, thus reducing the credit’s value for students. Indexing both the credit and the phaseout ranges would maintain the real value of the credit over time.  However, because the cost of higher education has risen much faster than the overall inflation rate, the credit would still likely cover a smaller share of education costs in future years.

Additional Resources
Stimulus Act Report Card: “American Opportunity” Tax Credit
Tax Topics: Education Tax Incentives
Description of Revenue Provisions Contained in the President’s Fiscal Year 2010 Budget Proposal; Part One: Individual Income Tax and Estate and Gift Tax Provisions (JCS-2-09), Joint Committee on Taxation, September 2009, pp 104-109