The Smiths son, Jake, is 19 and a full-time student in his second year of college. Jake paid $5,650 in tuition during 2015, and another $650 for textbooks. The Smiths are claiming Jake as a dependent. Their taxable income is $13,000, and their tax liability before credits is $1,300. How much benefit will the Smiths receive from the American Opportunity Credit for Jake?
To determine how much benefit the Smiths will receive from the American Opportunity Credit for Jake, we need to follow these steps:
1. Confirm eligibility: The American Opportunity Credit is available to eligible taxpayers who pay qualified education expenses for an eligible student. The student must be enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. In this case, Jake is a full-time student in his second year of college, so he meets the eligibility criteria.
2. Calculate qualified education expenses: In this case, Jake paid $5,650 in tuition and $650 for textbooks. Both of these expenses are considered qualified education expenses. Therefore, the total qualified education expenses amount to $5,650 + $650 = $6,300.
3. Determine the credit amount: The American Opportunity Credit allows taxpayers to claim a credit of up to $2,500 per eligible student per year. However, the credit is phased out for taxpayers with modified adjusted gross income (MAGI) above certain thresholds.
The Smiths' tax liability before credits is $1,300. The American Opportunity Credit is a non-refundable credit, which means it can only reduce the taxpayers' liability to zero, but any excess credit cannot be received as a refund.
If the credit amount were $2,500, it would fully offset the Smiths' tax liability. But because their taxable income is $13,000 and their tax liability before credits is $1,300, it means their effective tax rate is 10% ($1,300 / $13,000).
The American Opportunity Credit is worth 100% of eligible expenses up to $2,000 and 25% of eligible expenses over $2,000 but less than $4,000. In this case, since Jake's eligible expenses amount to $6,300, the Smiths can claim a credit of $2,000 (100% of the first $2,000) + $1,075 (25% of the remaining $4,300).
However, because the maximum credit amount is $2,500, they can only claim up to that limit to offset their tax liability.
Therefore, the Smiths will receive a benefit of $1,300 (their tax liability) - $2,000 (100% of the first $2,000) - $500 (25% of the remaining $2,000) = -$200. Since the credit cannot exceed the tax liability, the Smiths will not receive a direct benefit from the American Opportunity Credit.