Making the American Opportunity Tax Credit Work for Low-Income People
By Andy Beres
In today's economy, postsecondary credentials are essential to secure good jobs that pay a family-sustaining wage. But with college costs rising rapidly, it can be difficult for low-income people to access higher education. For these individuals, federal student aid is critical to make college attendance possible. However, the average full-time, low-income student has about $6,000 in unmet need after accounting for Pell Grants and other financial aid.
The American Opportunity Tax Credit (AOTC) is also designed to make postsecondary education more affordable. Depending on the amount of qualified expenses (tuition, required fees, and course materials), the AOTC allows students and their parents to reduce their federal income taxes by up to $2,500 per eligible student. Up to 40 percent of the tax credit ($1,000) is refundable.
Unfortunately, the AOTC has a limited impact for low-income people because students can only obtain the credit after filing a tax return at year’s end—not when tuition and other costs are due. Moreover, the process for obtaining and maximizing the AOTC can be complex and confusing. These issues severely undermine the goal of the AOTC to improve access to postsecondary education. But new recommendations from CLASP, as well as guidance from the U.S. Treasury, could help make the AOTC more effective.
Help When It’s Needed: Advancing the AOTC, released today by CLASP, proposes an Advance AOTC—a new process that would allow students to receive all or part of the AOTC when college bills are due. The proposal also calls for the U.S. Department of Education and colleges to include information about the AOTC and Advance AOTC in the Free Application for Federal Student Aid (FAFSA) and in financial aid award letters.
Additionally, CLASP proposes a new IRS tool called My College Tax Credit Assistant, which would: help students and families understand and claim the AOTC; estimate how much AOTC is available to students; serve as a data hub matching colleges’ information with taxpayer-supplied data to cut down on red tape; and eliminate the confusing IRS Forms 8863 and 1098-T.
These reforms would be a game changer for low-income students. By strengthening outreach to students and families, streamlining the process for obtaining the AOTC, and delivering benefits when they will make the most difference, we can significantly improve college enrollment and persistence rates—giving students the education they need to succeed and strengthening our economy through a more skilled workforce.
CLASP’s recommendations come one week after the U.S. Treasury published Interaction of Pell Grants and Tax Credits: Students May Be Foregoing Tax Benefits by Mistake, a fact sheet with guidance on how students and families can get the most mileage out of student aid and education tax credits. According to the Treasury, students and families leave hundreds of millions of dollars on the table every year because they aren’t aware of their options.
Existing law allows students to choose whether to apply their Pell Grant funds to tuition, fees, and course-related materials or living expenses—or a combination of both. If a student applies Pell funds to tuition and fees, that reduces the total expenses she can claim under the AOTC; if she applies Pell funds to living expenses, it becomes taxable income.
Determining which option will be most advantageous can be confusing for students and their families. The ideal solution is to adopt policies, such as those proposed by CLASP, that reduce complexity. However, in the immediate term, it’s critical that everyone involved in the process—including college financial aid offices, tax preparers, and others who work with students—work to ensure students and their families understand their options and can make informed decisions that maximize their AOTC benefits and Pell funds. As part of its Benefits Access for College Completion program, CLASP is working with participating colleges to disseminate this information to their students.
We can’t change the system overnight. But there is outreach we can do now—and long-term solutions we can build toward—to help low-income students access, persist in, and complete the postsecondary education they need to obtain good jobs and promote economic growth.
Help When It’s Needed was published by CLASP as part of its participation in the Consortium for Higher Education Tax Reform. The Consortium is a partnership funded by the Bill & Melinda Gates Foundation as part of its Reimagining Aid Design and Delivery (RADD) initiative. Other members include the New America Foundation’s Education Policy Program, Young Invincibles, and Education Trust.
To read Help When It’s Needed, click here.
To read the U.S. Treasury fact sheet, click here.