How Best to Leverage AOTC When Usually Receive Tax Refund?

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Megamill
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How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sat Aug 24, 2019 9:23 am

A couple questions for all who have claimed the AOTC for your kids' college tuition/expenses:

1. If DS starts first year of college in Fall of 2020, and we pay first semester tuition at that time, we'd be eligible for the credit when filing 2020 income tax, right?

2. We typically receive a fed tax refund because I purposely, for years, have over withheld (I know, I know, please no lectures on how we should not be giving the fed government an interest-free loan like that.) Should I change my withholding in early 2020 so that we take advantage of the entire $2,500 credit rather than leave any $ on the table while at the same time, try not to end up with a bill for 2020 taxes owed (and the subsequent 3 years in college)?

3. Any other tips on maximizing the AOTC? (btw, we don't have a 529 so no complexity with segregating funding sources.)

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grabiner
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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by grabiner » Sat Aug 24, 2019 4:01 pm

The "non-refundable" credit is independent of whether you receive a refund when you file your taxes. A credit is non-refundable if it cannot reduce your tax below zero. You may still get a refund if you overpaid your taxes.

However, if you are expecting to receive a tax credit, you should reduce your withholding so that you actually get the money. A $2500 tax credit corresponds to claiming two or three fewer withholding allowances in a 22%-24% bracket, or five fewer in a 12% bracket.

The biggest issue with expecting a tax refund is not the interest-free loan (which is a trivial cost at today's rates) but the possibility that something goes wrong and your refund is delayed. I have had three state tax refunds delayed because of errors (two by the state, one by me).
Wiki David Grabiner

marcopolo
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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by marcopolo » Sat Aug 24, 2019 5:21 pm

I think you might have a misunderstanding on how the tax credit works.

It is credited against the entire tax bill for the year, not just what you owe at tax filing time. So, even if you over withheld, as long as you had sufficient total taxes due for the year, you will have the full amount credited against your taxes due and will simply get an even bigger refund.

The term non-refundable simply means that if your total taxes due for the year is less than the tax credit, then you done get more back than you actually paid. That does not appear to be what you are asking about.
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Kenkat
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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Kenkat » Sat Aug 24, 2019 6:46 pm

Yes to question 1.

Yes to question 2. While the fact that you are already getting a refund doesn’t matter in claiming the AOTC credit (which I think you understand), you might as well adjust your withholding so that you don’t get an even bigger refund. I did this when I had two in college and have upped withholding once the older child was finished with college and could also no longer be claimed as a dependent.

#3 just make sure you pay at least $4,000 out of pocket for every year you want to claim the AOTC.

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 8:35 am

Kenkat wrote:
Sat Aug 24, 2019 6:46 pm
#3 just make sure you pay at least $4,000 out of pocket for every year you want to claim the AOTC.
Can you explain why I would need to pay at least $4k out of pocket to claim the AOTC? Wouldn't the minimum you need to pay out of pocket be $2,500 (the max amount of AOTC)?

Also, if you pay for the Fall semester in 2020 and Spring semester isn't paid until 2021, and if each semester is less than $4k, how would you be able to claim it the first year of the 4 years?

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 8:41 am

marcopolo wrote:
Sat Aug 24, 2019 5:21 pm
I think you might have a misunderstanding on how the tax credit works.

It is credited against the entire tax bill for the year, not just what you owe at tax filing time. So, even if you over withheld, as long as you had sufficient total taxes due for the year, you will have the full amount credited against your taxes due and will simply get an even bigger refund.
You are right marcopolo, I don't completely get how tax credits work. Deductions are easy, but credits (nonrefundable credits) are not as straight forward when there is already a refund due. So hypothetically, let's say that after all my deductions and taxes paid for the year, I am due a $3,200 refund. If I claimed the AOTC, it would do me no good, right? Well except that I think I would receive a total refund of $4,200 because I read that up to $1k is refundable.

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 8:45 am

grabiner wrote:
Sat Aug 24, 2019 4:01 pm
The biggest issue with expecting a tax refund is not the interest-free loan (which is a trivial cost at today's rates) but the possibility that something goes wrong and your refund is delayed. I have had three state tax refunds delayed because of errors (two by the state, one by me).
[/quote
Good point.

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by marcopolo » Sun Aug 25, 2019 9:10 am

Megamill wrote:
Sun Aug 25, 2019 8:41 am
marcopolo wrote:
Sat Aug 24, 2019 5:21 pm
I think you might have a misunderstanding on how the tax credit works.

It is credited against the entire tax bill for the year, not just what you owe at tax filing time. So, even if you over withheld, as long as you had sufficient total taxes due for the year, you will have the full amount credited against your taxes due and will simply get an even bigger refund.
You are right marcopolo, I don't completely get how tax credits work. Deductions are easy, but credits (nonrefundable credits) are not as straight forward when there is already a refund due. So hypothetically, let's say that after all my deductions and taxes paid for the year, I am due a $3,200 refund. If I claimed the AOTC, it would do me no good, right? Well except that I think I would receive a total refund of $4,200 because I read that up to $1k is refundable.
No, you are still confusing your total taxes due with what is owed/refunded at tax filing time. The credit applies to your total taxes due for the year, not what you might owe or get back when you file.

An easier way to think about this is to look at you tax return. There is a line that shows your total tax for the year. For 2018 1040 form, that is on line 15, called "total tax". If that is greater than than the credit amount ($2500 in the case of the AOTC), then you get the whole $2500 back. The fact that you may have had too much withheld does not change that. So, even if you over paid and are getting a $3200 refund otherwise, as long as the total tax is over $2500, you will get the full credit, and your refund will increase to $5700.

I would recommend you use some tax software to run the different scenarios so you can see the actual effects for yourself.
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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by teen persuasion » Sun Aug 25, 2019 9:17 am

Megamill wrote:
Sun Aug 25, 2019 8:35 am
Kenkat wrote:
Sat Aug 24, 2019 6:46 pm
#3 just make sure you pay at least $4,000 out of pocket for every year you want to claim the AOTC.
Can you explain why I would need to pay at least $4k out of pocket to claim the AOTC? Wouldn't the minimum you need to pay out of pocket be $2,500 (the max amount of AOTC)?

Also, if you pay for the Fall semester in 2020 and Spring semester isn't paid until 2021, and if each semester is less than $4k, how would you be able to claim it the first year of the 4 years?
I believe the AOTC is 100% of the first $2k, and 25% of the next $2k of tuition paid OOP (not from scholarships, grants, or 529 funds).

Regarding payment schedules, some schools deliberately bill both semesters before December 31, (say Aug 8 deadline for fall, and Dec 8 deadline for the following spring) so you get two semesters paid in a single year. This lines up nicely with the 4 year limit to eligibility for AOTC. Some schools don't bill spring semester until after Jan 1, so there's no way to pay both semesters the first and last years. You end up with a 1/2, 1, 1, 1, 1/2 cycle spanning 5 years, but the AOTC can only be taken 4 times. You could use the LLL (lifelong learning) credit after the AOTC is exhausted, but it's a smaller percentage (maybe 10%?).

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Megamill
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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 9:43 am

Megamill wrote:
Sun Aug 25, 2019 8:45 am
There is a line that shows your total tax for the year. For 2018 1040 form, that is on line 15, called "total tax". If that is greater than than the credit amount ($2500 in the case of the AOTC), then you get the whole $2500 back. The fact that you may have had too much withheld does not change that. So, even if you over paid and are getting a $3200 refund otherwise, as long as the total tax is over $2500, you will get the full credit, and your refund will increase to $5700.
omg, that sounds way better. I absolutely pay way more than $2,500 in fed taxes every year, so then I wouldn't need to mess with the withholding (if I don't want to). I was thinking I had to somehow balance this out to make the most of the credit. Another thought I had was maybe to increase my Roth 401k contributions during the years that the kiddos are in college. Food for thought.
marcopolo wrote:
Sun Aug 25, 2019 9:10 am
I would recommend you use some tax software to run the different scenarios so you can see the actual effects for yourself.
Good idea to run a simulation. Thanks!

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 9:47 am

teen persuasion wrote:
Sun Aug 25, 2019 9:17 am
Regarding payment schedules, some schools deliberately bill both semesters before December 31, (say Aug 8 deadline for fall, and Dec 8 deadline for the following spring) so you get two semesters paid in a single year. This lines up nicely with the 4 year limit to eligibility for AOTC.
Good to know. I will check out the billing schedule and include that in the tax planning. Thanks!

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Kenkat » Sun Aug 25, 2019 9:48 am

teen persuasion wrote:
Sun Aug 25, 2019 9:17 am
Megamill wrote:
Sun Aug 25, 2019 8:35 am
Kenkat wrote:
Sat Aug 24, 2019 6:46 pm
#3 just make sure you pay at least $4,000 out of pocket for every year you want to claim the AOTC.
Can you explain why I would need to pay at least $4k out of pocket to claim the AOTC? Wouldn't the minimum you need to pay out of pocket be $2,500 (the max amount of AOTC)?

Also, if you pay for the Fall semester in 2020 and Spring semester isn't paid until 2021, and if each semester is less than $4k, how would you be able to claim it the first year of the 4 years?
I believe the AOTC is 100% of the first $2k, and 25% of the next $2k of tuition paid OOP (not from scholarships, grants, or 529 funds).

Regarding payment schedules, some schools deliberately bill both semesters before December 31, (say Aug 8 deadline for fall, and Dec 8 deadline for the following spring) so you get two semesters paid in a single year. This lines up nicely with the 4 year limit to eligibility for AOTC. Some schools don't bill spring semester until after Jan 1, so there's no way to pay both semesters the first and last years. You end up with a 1/2, 1, 1, 1, 1/2 cycle spanning 5 years, but the AOTC can only be taken 4 times. You could use the LLL (lifelong learning) credit after the AOTC is exhausted, but it's a smaller percentage (maybe 10%?).
Yes, correct!

You get the first $2000 back dollar for dollar but the next $2000 is at 25% for the rest of the credit ($500).

Also remember it is based on amount PAID in a given year, not billed. So if a school does bill for say spring semester before the end of the prior year, you actually have to pay it in the prior year as well.

It’s not hard to get to $4000 for a semester at most colleges :|

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by marcopolo » Sun Aug 25, 2019 10:03 am

teen persuasion wrote:
Sun Aug 25, 2019 9:17 am

I believe the AOTC is 100% of the first $2k, and 25% of the next $2k of tuition paid OOP (not from scholarships, grants, or 529 funds).

Money taken from 529 accounts can still be used to claim the AOTC (if otherwise eligible). The earnings portion of that become taxable income on a pro-rata basis (but there is no 10% penalty).
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Katietsu » Sun Aug 25, 2019 10:05 am

1. Another way to think of it: How much would you owe if you had no withholding and made no estimated tax payments. Barring special circumstances, this is the amount eligible to be offset by non refundable credits.

2. Try to get the $4000 of payments this fall. Remember that the qualified expenses includes required books, supplies, fees and equipment. Please keep documentation and read what qualifies. You can also include tuition paid in 2019 for a semester starting within the first 3 months of 2020.

It might make sense to split your spring semester payment. For instance: Assume tuition per semester is $2500 and $500 was spent on books and supplies in fall 2019. Then I would pay $1000 of the spring bill by Dec 31. I would then pay the remainder in January to by used on next year’s tax return.

Qualified expenses can be paid with just your own regular old cash. But amounts paid by student loans for either the student or the parent also qualify. Amounts covered by grants and tax free scholarships do not.

I have simplified some of this, hopefully without changing the meaning. Please see IRS Publication 970 for more details.

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Megamill » Sun Aug 25, 2019 11:08 am

Thank you all for the very helpful info. For some reason I was over complicating all of this based on articles I have read about AOTC. One other question I just thought of...I have a bunch of iBonds that I don't have the total interest to date handy. I purchased them over the years with the intention for funding future college expenses. If I redeem some of them to pay for tuition, I understand that the interest will not be taxable. How does that affect AOTC? I was also thinking that if we just cash flow college, we would hang onto the iBonds--not sure what is best for us...

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Re: How Best to Leverage AOTC When Usually Receive Tax Refund?

Post by Kenkat » Sun Aug 25, 2019 12:12 pm

Megamill wrote:
Sun Aug 25, 2019 11:08 am
Thank you all for the very helpful info. For some reason I was over complicating all of this based on articles I have read about AOTC. One other question I just thought of...I have a bunch of iBonds that I don't have the total interest to date handy. I purchased them over the years with the intention for funding future college expenses. If I redeem some of them to pay for tuition, I understand that the interest will not be taxable. How does that affect AOTC? I was also thinking that if we just cash flow college, we would hang onto the iBonds--not sure what is best for us...
Tuition paid for with I Bonds or EE Bonds and claiming tax free interest cannot go towards the $4000 used to get the full credit of the AOTC. So if you redeemed $2000 worth of bonds to use tax free for tuition, you’d have to have at least $6,000 in eligible college expenses to claim the full AOTC.

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