This Is a Little Known Tax Credit You Should No Longer Ignore

The Hope Credit, which is the previous and perhaps better known name of the American Opportunity Tax Credit, is a federal tax break that can help people pay for college or trade school. This credit offers up to $10,000 in tax credits per student over four years to cover qualifying educational expenses. Students pursuing degrees at accredited institutions may be eligible for the tax break, subject to income restrictions and other qualifications. To find ways to pay for education and get help with tax questions, consider working with a financial advisor.

Hope Credit Background

The Hope Credit came into existence with passage of the Tax Relief Act of 1997. It was part of a package of education assistance measures included in that legislation, which also included the Lifetime Learning Credit.

In 2009, the American Recovery and Reinvestment Act extended the Hope Credit to the American Opportunity Tax Credit (AOTC). In addition to giving the Hope Credit a new name, the AOTC expanded the benefits available.

One major expansion doubles the time period for which the credit can be claimed. The Hope Credit covered only expenses from the first two years of post-secondary education. AOTC expands that to four years.

Also, AOTC allows taxpayers to claim credit for any money they spend to purchase course-related books, supplies and equipment. This could, for example, include a laptop computer if required for the course of study. If you pay for the educational program with borrowed funds, such as credit cards or student loans, those funds still count as qualified expenses. However, qualified expenses do not include tax-free fellowships or scholarships, tuition grants from an employer, federal Pell grants, refunds from the school and other non-taxable assistance other than gifts and inheritances.

Who Qualifies for the Hope Credit?

On a given year's tax return, each student can claim just one federal income tax education credit, including this one. The student has to be the taxpayer, the taxpayer's spouse or a dependent listed on the taxpayer's return. The student or the student's family can claim the credit for a total of four years.

It's only good for students who have not finished four years of college, even if they have not applied for the credit previously, or haven't gotten it for the allowed four years. Students also must not have been convicted on a felony drug charge during the year.

It is available to students enrolled at least half-time for at least one semester, trimester or quarter of the tax year. Only enrollment in post-secondary schools that meet the U.S. education department's requirements to participate in financial aid programs will satisfy this requirement.

Eligible institutions don't have to be traditional four-year colleges or universities. They could include other post-secondary educational institutions, such as community colleges teaching technical trades. The Department of Education maintains an online searchable database of accredited schools and programs here.

What Is the Hope Credit Worth?

This education tax credit is worth a maximum of $2,500 per tax year. This includes all of the first $2,000 of qualified expenses paid for each eligible student. The taxpayer can also claim 25% of the next $2,000 of eligible expenses, or up to another $500. Note that this tax credit is different from a deduction, which reduces taxable income. The education tax credit reduces the amount of tax owed by the amount of the credit.

A taxpayer who claims this credit can even qualify for a refund of up to $1,000. To get the $1,000 refund, a taxpayer has to claim the full allowed $2,500 education tax credit and owe no taxes. For tax credits of less than $2,500, the refund is determined by multiplying the amount of the claimed credit by 40%.

Income Restrictions, Receipt Requirements

To claim this credit, students or their families must meet income restrictions based on modified adjusted gross income (MAGI). The full credit is available to a single filer with a MAGI of no more than $80,000, or a married couple filing jointly with MAGI of $160,000.

Taxpayers with somewhat higher MAGI amounts can still qualify for smaller credits. However, at $90,000 or single filers and $180,000 for joint filers eligibility for the credit disappears completely.

Before using this credit, be sure you are eligible and can document that with receipts. If you claim it on your return and the IRS determines your documents don't support the claim, you will have to pay back the amount of the credit plus interest. You may also be charged a penalty for fraud and be banned from claiming the credit for up to 10 years.

Bottom Line

The Hope Credit, now known as the American Opportunity Tax Credit, can provide federal tax credits worth up to $2,500 annually per eligible student. The credits are available for up to four years for qualifying expenses, which can include tuition, books and other costs of higher education. To be eligible, students have to take courses from an accredited institution of higher learning, and also meet income requirements.

Tips on Taxes

• Working with a qualified and experienced financial advisor can help ensure you get every available tax credit. Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

• Use this no-cost federal income tax calculator to get a quick estimate of what you owe.

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