In a blog posted to the Department of Treasury website earlier this week, the Obama Administration highlighted the complicated interaction between the Pell Grant and American Opportunity Tax Credit (AOTC). Difficulties in understanding how to optimally claim college benefits at tax time is likely causing some high-need students and families to miss out on the full amount of benefits they might otherwise receive. To assist students, Treasury has partnered with the Department of Education (ED) to create a fact sheet that outlines how and when a student should allocate the Pell Grant to tuition, fees, and course related materials, or to living expenses when filing a tax return.
AOTC is a tax credit that many students can claim in the first four years of postsecondary education, and it provides a 100 percent credit for the first $2,000 of “qualified tuition and related expenses,” and a 25 percent credit for the next $2,000, with a maximum possible credit of $2,500. Qualified tuition and related expenses typically includes tuition, fees, and course materials. Critically, the AOTC is a refundable credit, and over 11 million families benefit from the program each year.
The complication when filing for AOTC arises related to the treatment of Pell, or other forms of grant and scholarship dollars, for tax purposes. Scholarships can be treated as tax-free and must be subtracted from AOTC-eligible expenses, or scholarships can be taxable and not subtracted from AOTC-eligible expenses. Students, under current law, can decide how they would like to treat their Pell, and other scholarships, yet most students and families are unaware of this, or not sure how to decide correctly-- which for many students, would be to include at least a portion of their scholarship dollars in taxable income in order to maximize their benefit under AOTC.
The Treasury blog post suggests that a good rule of thumb for most Pell recipients is to claim at least $2,000 in tuition and fees for the AOTC even if that means counting a portion of their scholarship as taxable income. They do note, however, that “the right choice depends on the student’s and their family's circumstances and involves numerous factors, such as the amount of tuition and living expenses, the amount and terms of their scholarship, the income of the student and their family, and other tax-related factors.”
Furthering the administration’s outreach, the Internal Revenue Service (IRS) has made information available on this topic, and is modifying the Q&A on their website to provide additional assistance to students and families related to the AOTC. Additionally, Treasury and ED are exploring partnerships with tax preparation companies and tax preparers to better educate consumers during the next year’s tax filing season. The President’s FY15 Budget also contained a proposal to simplify the AOTC for Pell recipients to avoid the complicated decisions described above, but until such a solution can be found, the administration will continue to work on outreach and education efforts.
Publication Date: 6/12/2014