Education Planning - Federal Tax Breaks
By Peter Jason Riley
Tax breaks to help you pay educational expenses are some of the most commonly overlooked federal tax breaks, they shouldn't be. These are very valuable tax breaks and we can help you maximize your tax savings. These incentives can provide hundreds and sometimes thousands of dollars of tax reduction off the total tax bill of families, not only for children in college or graduate school, but also for parents to pursue further education and training to help them at work.
Maximizing the benefits from the education tax breaks careful planning, particularly because of the interrelationship between many of the rules. Although the IRS provides guidance, some of the IRS' explanations have actually complicated matters in some circumstances.
Let's take a look at some of the education tax incentives:
HOPE and Lifetime Learning credits. Two credits, which can be very attractive if you qualify, are the HOPE credit and the Lifetime Learning credit. The HOPE credit can reach as high as 100 percent of up to $1,200 in 2008 of qualified higher education expenses plus 50 percent of the next $1,200 of eligible expenses. The maximum credit is $1,800 for 2008. The benefit of the credit begins to "phase out" for married couples filing jointly with more than $96,000 in adjusted gross income (AGI) in 2008. The credit begins to phase out for single individuals with more than $48,000 in AGI in 2008. The HOPE credit applies to qualified tuition and related expenses of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer for whom the taxpayer claimed a personal exemption. Generally, the credit can be claimed if you pay qualified tuition and related expenses for the first two years of post-secondary education. Some tricky rules on course-load levels and covered expenses apply.
The Lifetime Learning credit is similar to the HOPE credit but has some important differences. For example, the Lifetime Learning credit is not limited to the first two years of post-secondary education. A student also does not need to be pursuing a degree or other recognized education credential to take advantage of the credit. The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. Like the HOPE credit, the Lifetime Learning credit is subject to phase-out rules. The credit begins to phase-out for married couples filing jointly with more than $96,000 in AGI in 2008. The credit begins to phase-out for single individuals with more than $48,000 in AGI in 2008.
Higher education deduction. Starting in 2002, Congress introduced an above-the-line deduction for qualified tuition and related expenses. The Emergency Economic Stabilization Act of 2008 renews the deduction for 2008 and extends it through 2009. Eligible expenses include those spent on behalf of the taxpayer, his or her spouse or dependents at a post-secondary institution. The college or school must be eligible to participate in the federal student loan program. The amount of the deduction depends on your AGI.
Section 529 plans. The Tax Code allows states and some educational institutions to offer "529" plans (known for the section of the Tax Code that governs them). They are also sometimes called qualified tuition programs (QTPs). They allow you to either prepay or contribute to an account for paying a student's post-secondary education expenses. An eligible educational institution generally includes colleges, universities, vocational schools or other post-secondary educational institutions. In addition, distributions from state programs, even to the extent of earnings, are now entirely tax-free to the extent used for qualified higher education expenses. Beginning in 2004, this tax-free treatment also has been available for distributions from private college and university programs. Investment gains before those dates are taxed to the student.
Coverdell education savings accounts. Coverdell education savings accounts (also sometimes called education IRAs) are similar to IRAs. You can save today for future educational expenses and not just higher educational expenses. Funds in a Coverdell ESA can also be used for K-12 and related expenses. The maximum annual Coverdell ESA contribution is $2,000 per beneficiary. Contributions are not deductible by the donor and are not included in the beneficiary's income as long as they are used to pay for qualified education expenses. Contributions generally must stop when the beneficiary turns age 18 except for individuals with special needs. Parents can maximize benefits, however, by transferring older siblings' accounts for use by a younger brother, sister or first cousin, thereby maximizing the tax-free growth period. Excess contributions are subject to an excise tax.
The phase-out amounts of adjusted gross income allowed for a contributor to a Coverdell ESA are generous. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals.
Education savings bond interest exclusion. When you use U.S. savings bonds to pay higher education expenses , the interest may be excluded from income if your income is below a certain range. For 2008, the phase-out begins at $67,100 for individuals and $100,650 for married couples filing jointly. You must use the bonds to pay for tuition and fees at a post-secondary institution. Generally, you must redeem the bonds and not transfer them to the school.
Employer-provided educational assistance exclusion. Another valuable tax break is the exclusion of up to $5,250 of employer-provided education assistance paid under an employer's qualified educational assistance program. Excludable education allowances from an employer need not be related to the employee's current job. Graduate-level courses are also covered.
Deduction for interest on education loans. Student loan interest of up to $2,500 a year is deductible whether or not you itemize your deductions. The deduction begins to phase out for single individuals with modified AGI above $55,000 and for married couples filing jointly with modified AGI above $110,000. However, the rules can be tricky. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person's return cannot take this deduction.
IRAs. The Tax Code also allows you to withdraw funds from your IRA tax-free for qualified educational expenses. The education must be for you, your spouse, or the children or grandchildren of you or your spouse and at a qualified post-secondary institution. This is a great way to help grandchildren pay for post-secondary education.
Looking ahead, there is a lot of talk in Congress about simplifying and possibly consolidating all of the educational tax breaks. Meanwhile, we have to live with the rules as they are. Undoubtedly, some of these provisions will be more important to you than others, depending upon personal circumstances.