«Congressional Research Service 7-5700 R42561 The American Opportunity Tax Credit: Overview, Analysis, and Policy Options Summary The ...»
The American Opportunity Tax Credit:
Overview, Analysis, and Policy Options
Margot L. Crandall-Hollick
Analyst in Public Finance
July 10, 2014
Congressional Research Service
The American Opportunity Tax Credit: Overview, Analysis, and Policy Options
The American Opportunity Tax Credit (AOTC)—enacted on a temporary basis by the American
Recovery and Reinvestment Act (ARRA; P.L. 111-5) and extended through the end of 2017 by the American Taxpayer Relief Act of 2012 (P.L. 112-240; ATRA)—is a partially refundable tax credit that provides financial assistance to taxpayers who are attending college, or whose children are attending college. The credit, worth up to $2,500 per student, can be claimed for a student’s qualifying expenses incurred during the first four years of post-secondary education. In addition, 40% of the credit (up to $1,000) can be received as a refund by taxpayers with little or no tax liability. The credit phases out for taxpayers with income between $80,000 and $90,000 ($160,000 and $180,000 for married couples filing jointly) and is hence unavailable to taxpayers with income above $90,000 ($180,000 for married couples filing jointly). There are a variety of other eligibility requirements associated with the AOTC, including the type of degree the student is pursuing, the number of courses the student is taking, and the type of expenses which qualify.
Prior to the enactment of the AOTC, there were two permanent education tax credits, the Hope Credit and the Lifetime Learning Credit. The AOTC has temporarily replaced the Hope Credit from 2009 through the end of 2017 (the Lifetime Learning Credit remains unchanged). A comparison of these two credits indicates that the AOTC is both larger—on a per capita and aggregate basis—and more widely available in comparison to the Hope Credit. Data from the Internal Revenue Service (IRS) indicate that enactment of the AOTC contributed to a more than tripling of both the aggregate value of education credits claimed by taxpayers and the number of taxpayers claiming these credits.
Education tax credits were intended to provide federal financial assistance to students from middle-income families, who may not benefit from other forms of traditional student aid, like Pell Grants. The enactment of the AOTC reflected a desire to continue to provide substantial financial assistance to students from middle-income families, while also expanding the credit to certain lower- and upper-income students. A distributional analysis of the AOTC highlights that this benefit is targeted to the middle class, with more than half (53%) of the estimated $16 billion of AOTCs in 2009 going to taxpayers with income between $30,000 and $100,000.
One of the primary goals of education tax credits, including the AOTC, is to increase college attendance. Studies analyzing the impact education tax incentives have had on college attendance are mixed. Recent research that has focused broadly on education tax incentives that lower tuition costs and have been in effect for several years, including the Hope and Lifetime Learning Credits, found that while these credits did increase attendance by approximately 7%, 93% of credit recipients would have attended college in their absence. Even though the AOTC differs from the Hope Credit in key ways, there are a variety of factors that suggest this provision may also have a limited impact on increasing college attendance. In addition, a recent report from the Treasury Department’s Inspector General for Tax Administration (TIGTA) identified several compliance issues with the AOTC.
There are a variety of policy options Congress may consider regarding the AOTC, including extending the credit, extending a modified AOTC, or repealing the Hope and Lifetime Credits and extending a modified AOTC that includes provisions included from both credits. Alternatively, Congress may want to examine alternative ways to reduce the cost of higher education. This report discusses these issues and concludes with an overview of selected proposals to modify the AOTC, including those provided in Chairman Camp’s tax reform proposal and in H.R. 3393.
Congressional Research Service The American Opportunity Tax Credit: Overview, Analysis, and Policy Options Contents Introduction
Calculating the Credit
Qualifying Education Expenses
Who Benefits from the AOTC?
Does the AOTC Increase College Attendance?
Are Ineligible Taxpayers Erroneously Claiming the AOTC?
Allow the AOTC to Expire as Scheduled
Extend or Modify the AOTC
Consolidate the AOTC with Other Education Tax Benefits
Alternative Policies to Reduce the Cost of Higher Education
Selected Proposals in the 113th Congress to Modify the AOTC
Camp Tax Reform Proposal
The FY2015 Obama Administration Proposal
Figures Figure 1. Amount of Education Tax Credits Claimed from 1998-2011
Figure 2. Share of the AOTC and Hope Credit, by Income
Tables Table 1. Comparison of the AOTC and the HOPE Higher Education Tax Credits
Table 2. Share of AOTC Received by Taxpayers at Different Income Levels, 2011
Table A-1. Key Parameters of the Lifetime Learning Credit and the Tuition and Fees Deduction
Appendixes Appendix A. Other Tax Provisions For Current-Year Higher Education Expenses
Appendix B. Calculating the AOTC: A Stylized Example
Introduction The American Opportunity Tax Credit (AOTC) is a temporary tax provision that provides financial assistance to taxpayers whose children (or who themselves) are attending college. The AOTC is scheduled to expire at the end of 2017, at which point Congress may allow the provision to expire, extend the provision in its current form, or extend a modified version of the AOTC. In light of increased congressional interest in reforming the tax code, policy makers may choose to consider modifying the AOTC in conjunction with other education tax benefits.1 The Joint Committee on Taxation (JCT) estimated that all education tax benefits for individuals cost $46.7 billion in 2014. Higher education tax credits, of which the AOTC is the largest, accounted for $24.5 billion (52%) of the total.2 This report provides both an in-depth description of this tax credit and an analysis of its economic impact. This report is organized to first provide an overview of the AOTC, followed by a legislative history that highlights the evolution of education tax credits from proposals in the 1960s through the recent extension of the AOTC at the end of 2012. This report then analyzes the credit by looking at who claims the credit, the effect education tax credits have on increasing college attendance, and administrative issues with the AOTC. Finally, this report concludes with a brief overview of various policy options, including tax law changes proposed in Chairman Camp’s tax reform bill3 and in the President’s FY2015 budget request.
Current Law The American Opportunity Tax Credit (AOTC) allows eligible taxpayers to reduce their federal income taxes by up to $2,500 per eligible student. The credit was enacted as part of the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), temporarily replacing the Hope Credit for 2009 and 2010. The Hope Credit was originally enacted in 1997 as part of the Taxpayer Relief Act (P.L. 105-34). As outlined in Table 1, the AOTC modified several parameters of the Hope Credit. The AOTC was extended for 2011 and 2012 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312). Subsequently, the AOTC was extended for five more years, through the end of 2017, by the American Taxpayer Relief Act of 2012 (P.L. 112-240; ATRA). According to current law, beginning in 2018 taxpayers will no longer be able to claim the AOTC. However, taxpayers may still be eligible to claim either the Hope Credit or the Lifetime Learning Credit, both permanent tax provisions.
For more information on current education tax benefits, see CRS Report R41967, Higher Education Tax Benefits:
Brief Overview and Budgetary Effects, by Margot L. Crandall-Hollick.
Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2012-2017, February 1, 2013, JCS-1-13.
As of the date of this report, the Camp tax reform proposal has not been formally introduced and assigned a bill number.
Source: Internal Revenue Service, Publication 970: Tax Benefits for Education 2010 and Internal Revenue Service, Publication 970: Tax Benefits for Education 2008.
Notes: For the 2008 and 2009 tax years, as a result of The Heartland Disaster Tax Relief Act of 2008 (included in P.L. 110-343), taxpayers in Midwestern disaster areas were eligible to claim Hope or Lifetime Learning Credits that were double the regular value of the credits. Hence, in 2009, taxpayers could elect to claim the larger Hope Credit instead of the AOTC. The Hope Credit for taxpayers in Midwestern disaster areas was calculated as 100% of the first $2,400 of qualified expenses, plus 50% of the next $2,400, resulting in a maximum Hope Credit of $3,600. For more information, see http://www.irs.gov/newsroom/article/0,,id=203082,00.html.
a. The numeric parameters for the Hope Credit reflect the values as of 2008, the most recent year for which the credit was in effect. The credit is scheduled to return in 2018, at which time the annual limit and income phase-out ranges will be adjusted for inflation.
Calculating the Credit The AOTC is calculated as 100% of the first $2,000 of qualifying education expenses plus 25% of the next $2,000 of qualifying education expenses for each eligible student. Hence, to claim the maximum value of the credit, an eligible student will need to have incurred at least $4,000 in qualifying education expenses. The AOTC phases out for taxpayers with income4 above certain thresholds. Specifically, the AOTC begins to phase out when income exceeds $80,000 ($160,000 for married taxpayers filing jointly)5 and is completely phased out when income exceeds $90,000 ($180,000 for married taxpayers filing jointly). Thus, taxpayers with income over $90,000 ($180,000 or more for married taxpayers filing jointly) are ineligible for the AOTC.
The AOTC is partially refundable, meaning taxpayers with little to no tax liability may still be able to benefit from this tax provision. A tax credit is partially refundable if, in cases where the credit is larger than the taxpayer’s tax liability, the Internal Revenue Service (IRS) only refunds part of the difference. The refundable portion of the AOTC is calculated as 40% of the value of the credit the taxpayer is eligible for based on qualifying education expenses. Therefore, if the taxpayer was eligible for $2,500 of the AOTC, but had no tax liability, they could still receive $1,000 (40% of $2,500) as a refund. For an example on how to calculate the AOTC, see Appendix B.
Eligibility Requirements There are a variety of limitations concerning who can claim the AOTC and what expenses can be used to claim the credit. These provisions are outlined below.
Qualifying Student A qualifying student is either the taxpayer, the taxpayer’s spouse, or an individual whom a taxpayer can claim as a dependent6 (in many cases, the taxpayer’s child). Other requirements
include the following:
• Years of Postsecondary Education: The student must be in their first four years of post-secondary education, which for most students is the first four years of undergraduate education.7 In addition, a taxpayer cannot claim the AOTC for a student if they have claimed education credits (AOTC, Hope, or Lifetime Learning) for the same student for four or more years.8 Income is, for the purposes of the AOTC, Modified Adjusted Gross Income (MAGI), which is adjusted gross income (AGI) modified by adding back the value of (if applicable) the foreign earned income exclusion, the foreign housing exclusion, the foreign housing deduction, and the exclusion of income by bona fide residents of American Samoa or Puerto Rico.
Taxpayers who file their tax returns as “married filing separately” cannot claim the AOTC.
Taxpayers must claim an exemption on their tax returns for dependents who are eligible students in order to claim the credit.