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2012 Budget

Extend the American Opportunity Tax Credit

The economic stimulus act (“American Recovery and Reinvestment Act of 2009”) established and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the “American Opportunity” tax credit (AOTC) as a replacement for the Hope credit through 2012. The president proposes to make the AOTC permanent and index for inflation both the maximum expenditures eligible for the credit and the income thresholds above which the credit phases out, beginning after 2012.

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 spent on tuition, fees, and course materials during each of the first four years of postsecondary education for students attending school at least half time. The maximum credit is $2,500 a year. In contrast, the Hope credit was available for only the first two years of postsecondary education and was not refundable. As was the case for the Hope credit, taxpayers may not claim the AOTC for any expenses paid using funds from other tax-preferred vehicles such as 529 plans and Coverdell Savings Accounts. Each student in a household may claim the AOTC, the lifetime learning credit, or the deduction for tuition expenses in a given year—but not more than one of them. All students in the same home need not choose the same tax benefit. If the budget proposal does not pass, the Hope credit would return in 2012, after the expiration of the AOTC.

Forty percent of the AOTC is refundable , which makes it available to households with little or no tax liability. The maximum refundable credit is $1,000 (indexed for inflation), 40 percent of the $2,500 maximum total credit.

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 starting after 2012.

The larger, refundable credit would continue to extend educational assistance to low-income students, making it easier for them to afford college and thus encouraging attendance. 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. The credit’s phaseout boosts marginal tax rates for affected taxpayers and could discourage work effort for some students or parents. Because most students qualify for the credit, colleges might react by raising tuition, thereby shifting some of the benefits from students receiving the credit to colleges and, the case of public institutions, to state taxpayers. Extending the credit would cost an estimated $93.6 billion over the next ten years.

Additional Resources

Stimulus Act Report Card: “American Opportunity” Tax Credit.

Tax Topics: Education Tax Incentives.