tax benefits are available to help you pay higher education
costs, whether for your children or yourself.
Let's take a look at what's available
and how you can take advantage of these benefits to ease the
financial burden of paying for education.
SAVINGS ACCOUNTS (SECTION 530 PROGRAMS)
Starting in 2013, you can contribute up to $2,000 to a
Coverdell Education Savings account (a Section 530 program
formerly known as an Education IRA) for a child under 18.
These contributions are not deductible, but they do grow
tax-free until withdrawn. Contributions for any year, for
example, 2015 can be made through the (unextended) due date
for the return for that year (April 15, 2016).
Only cash can be contributed to a Section 530 account and you
cannot contribute to the account after the child reaches his
or her 18th birthday. Section 530 programs can also be used to
build up funds for primary and secondary education and the tax
rules are similar to those for higher education.
Anyone can establish and contribute to a Section 530 account,
including the child. You may establish 530s for as many
children as you wish, but the amount contributed during the
year to each account cannot exceed $2,000. The child need not
be a dependent, and, in fact, does not even need to be related
to you. The maximum contribution amount for each child is
subject to a phase-out limitation with a modified AGI between
$190,000 and $220,000 for joint filers and $95,000 and
$110,000 for single filers.
The child must be named (designated as beneficiary) in the
Coverdell document, but the beneficiary can be changed to
another family member (for example, to a sibling where the
first beneficiary gets a scholarship or drops out). And funds
can be rolled over tax-free from one child's account to
another's. Funds must be distributed not later than 30 days
after the beneficiary's 30th birthday (or 20 days after the
beneficiary's death if earlier). For special needs;
beneficiaries the age limits (no contributions after age 18,
distribution by age 30) don't apply.
are taxable to the person who gets the money, with these major
exceptions: Only the earnings portion is taxable (the
contributions come back tax-free). Also, even that part isn't
taxable income, as long as the amount withdrawn doesn't exceed
a child's qualified higher education expenses; for that year.
The definition of qualified higher education expenses"
includes room and board and books, as well as tuition.
In figuring whether withdrawals
exceed qualified expenses, expenses are reduced by certain
scholarships and by amounts for which tax credits (see
Educational Tax Credits, below) are allowed. If the amount
withdrawn for the year exceeds the education expenses for the
year, the excess is partly taxable under a complex formula.
There's another formula if the sum of withdrawals from this
530 program and from the qualified tuition (Section 529)
program exceed education expenses.
PROGRAMS (SECTION 529 PROGRAMS)
Every state now has a program allowing persons to prepay for
future higher education, with tax relief. There are two basic
plan types, with many variations among them:
The prepaid education arrangement. Here one is essentially
buying future education at today's costs, by buying education
credits or certificates. This is the older type of program and
tends to limit the student's choice to schools within the
state. Private colleges and universities may now offer this
Education savings accounts. Here, contributions are made
to an account to be used for future higher education.
In approaching state programs one must distinguish between
what the federal tax law allows and what an individual state's
program may impose.
You may open a Section 529 program in any state. Unlike
certain other tax-favored higher education programs, such as
the American Opportunity Tax Credit and Lifetime Learning
Credits, federal tax law doesn't limit the benefit to tuition,
but can also extend it to room, board, and books (individual
state programs could be narrower).
Contributions must be in cash, and must not total more than
reasonably needed for higher education (as determined
initially by the state). Neither account owner nor beneficiary
may direct investments, but the state may allow the owner to
select a type of investment fund (e.g., fixed income
securities), and to change the investment annually, and when
the beneficiary is changed. The account owner decides who gets
the funds (can pick and change the beneficiary) and is legally
allowed to withdraw funds at any time, subject to tax and
penalty discussed later.
Distributions from the fund are tax-free to the extent used
for qualified higher education expenses. Distributions used
otherwise are taxable to the extent of the portion which
A Section 529 distribution can be tax-free even though the
student is claiming an American Opportunity Tax Credit or
Lifetime Learning Credit, or tax-free treatment for a Section
530 Coverdell distribution, if the programs aren't covering
the same specific expenses.
EDUCATION TAX CREDITS
Two tax credits are available for education costs - the
American Opportunity Tax Credit and the Lifetime Learning
Credit. These credits are available only to taxpayers with
adjusted gross income below specified amounts.
HOW THESE CREDITS WORK
The amount of the credit you can claim depends on (1) how much
you pay for qualified tuition and other expenses for students
and (2) your adjusted gross income (AGI) for the year.
You must report the eligible student's name and Social
Security number on your return to claim the credit. You
subtract the credits from your federal income tax. If the
credit reduces your tax below zero, you cannot receive the
excess as a refund. If you receive a refund of education costs
for which you claimed a credit in a later year, you may have
to repay ("recapture") the credit.
Caution: If you
file married-filing separately, you cannot claim these
Which costs are eligible? Qualifying tuition and
related expenses refer to tuition and fees, and course
materials required for enrollment or attendance at an eligible
education institution. They now include books, supplies and
equipment needed for a course of study whether or not the
materials must be purchased from the educational institution
as a condition of enrollment or attendance.
"Related" expenses do not include room and board, student
activities, athletics (other than courses that are part of a
degree program), insurance, equipment, transportation, or any
personal, living, or family expenses. Student-activity fees
are included in qualified education expenses only if the fees
must be paid to the institution as a condition of enrollment
or attendance. For expenses paid with borrowed funds, count
the expenses when they are paid, not when borrowings are
Tip: If you pay qualified expenses
for a school semester that begins in the first three
months of the following year, you can use the prepaid
amount in figuring your credit.
Example: You pay $1,500 of tuition
in December 2015 for the winter 2016 semester, which
begins in January 2016. You can use the $1,500 in
figuring your 2015 credit. If you paid in January
instead, you would take the credit on your 2016 return.
Tip: As future year-end tax
planning, this rule gives you a choice of the year to
take the credit for academic periods beginning in the
first 3 months of the year; pay by December and take the
credit this year; pay in January or later and take the
credit next year.
Eligible students. You, your spouse, or an eligible
dependent (someone for whom you can claim a dependency
exemption, including children under age 24 who are full-time
students) can be an eligible student for whom the credit can
apply. If you claim the student as a dependent, qualifying
expenses paid by the student are treated as paid by you, and
for your credit purposes are added to expenses you paid. A
person claimed as another person's dependent can't claim the
credit. The student must be enrolled at an eligible education
institution (any accredited public, non-profit or private
post-secondary institution eligible to participate in student
Department of Education aid programs) for at least one
academic period (semester, trimester, etc.) during the year.
No "double-dipping." The tax law says that you can't
claim both a credit and a deduction for the same higher
education costs. It also says that if you pay education costs
with a tax-free scholarship, Pell grant, or employer-provided
educational assistance, you cannot claim a credit for those
Income Limits. To claim the American Opportunity Tax
Credit, your modified adjusted gross income (MAGI) must not
exceed $90,000 ($180,000 for joint filers). To claim the
Lifetime Learning Credit, MAGI must not exceed $65,000
($130,000 for joint filers). "Modified AGI" generally means
your adjusted gross income. The "modifications" only come into
play if you have income earned abroad.
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THE AMERICAN OPPORTUNITY TAX CREDIT
The American Opportunity Tax Credit was extended through tax
year 2017 by the American Taxpayer Relief Act of 2012. The
maximum credit, available only for the first four years of
post-secondary education, is $2,500 for tax years 2013 to
2017. You can claim the credit for each eligible student you
have for which the credit requirements are met.
Special Qualification Rules. In addition to being an
eligible student, he or she:
- Must be enrolled in a program leading
to a degree, certificate, or other recognized credential;
- Must be taking at least half of a normal full-time load of
courses, for at least one semester or trimester beginning in
the year for which the credit is claimed; and
- May not have any drug-related felony convictions.
Amount of credit. The maximum amount of the AOC credit
is $2,500. Generally, 40 percent of the AOC is now a
refundable credit for most taxpayers, which means that you can
receive up to $1,000 even if you owe no taxes.
LIFETIME LEARNING CREDIT
You may be able to claim a Lifetime Learning Credit of up to
$2,000 (20 percent of the first $10,000 of qualified expense)
for eligible students (subject to reduction based on your AGI).
Only one Lifetime Learning Credit can be taken per tax return,
regardless of the number of students in the family.
- The credit can help pay for
undergraduate, graduate and professional degree courses,
including courses to improve job skills.
- For courses taken to acquire or improve job skills, there
are no requirements as to course loads, so that even one or
two courses can qualify.
- The number of years for which this credit can be claimed is
Choosing the Credit. You can't claim both credits for
the same person in the same year. But you can claim one credit
for one or more family members and the other credit for
expenses for one or more others in the same year - for
example, an American Opportunity Tax Credit for your child and
a Lifetime Learning Credit for yourself.
Electing Not To Take the Credit. There are situations
in which the credit is not allowed, or not fully available, if
some other education tax benefit is claimed - where the higher
education expense deduction is claimed for the same student,
see below, or where credit and tax exemption (under a Section
529 or 530 program) are claimed for the same expense. In that
case the taxpayer - or, more likely, the taxpayer's tax
adviser - will determine which tax rule offers the greater
benefit and if it's not the credit, elect not to take the
QUALIFIED TUITION AND RELATED EXPENSES
DEDUCTION PHASED OUT FOR 2015
A $4,000 above the line deduction (Form 8917) for "qualified
higher education expenses" under the same definition as for
tuition credits, above, was allowed for qualified tuition
expenses in 2014, but has been phased out for 2015.
EMPLOYER-PROVIDED EDUCATION ASSISTANCE
If your employer paid education assistance benefits (e.g.,
reimbursements of tuition), part or all of them may be
tax-free. You can exclude up to $5,250 per year of the
benefits you receive under a qualified educational assistance
program. But you can't both exclude and deduct the same item,
even if it's otherwise deductible. In order to qualify, your
employer must have established an educational assistance plan
that does not discriminate in favor of highly paid employees
or owners. The exclusion applies to undergraduate level
courses other than those involving sports, game and hobbies.
The courses do not need to relate to your job. The exclusion
is available for tuition, fees, books, and supplies but not
meals, lodging or transportation. And it applies to benefits
for graduate level courses.
In addition to the exclusion for qualifying education plans,
your employer can provide reimbursement for business related
courses, including graduate courses. If your employer does not
reimburse you for these expenses, you may be entitled to
deduct them as a miscellaneous itemized deduction subject to
the 2 percent deduction floor. To qualify, the expense must
meet the requirement of your employer or the law or maintain
or improve skills in your current job. The course must not
meet minimum education requirements for your job or qualify
you for a new trade or business.
You may be able to deduct interest on student loans. You may
also be able to exclude income that you would otherwise have
to report if a student loan is canceled.
Interest Deduction. You may deduct student loan
interest you pay, including interest paid that's not currently
due because payment is deferred.
Deduction is allowed even though it would otherwise be
nondeductible personal interest. But you may deduct only if
you are the one legally bound to pay the interest, and only on
loans solely for qualified expenses (so not under open credit
The student-loan deduction (up to $2,500 starting in 2013),
was made permanent by AFTRA, but only to taxpayers whose AGI
is below $160,000 (joint filers) or $80,000 (single filers).
Married couples filing separately can't take the deduction.
The student-loan interest deduction is an "above the line"
deduction. In other words, you don't have to itemize in order
to claim it. The loan must have been taken out to cover
education expenses of at least half-time study for yourself,
your spouse, or a person who was your dependent when you took
out the loan.
Caution: You cannot deduct interest
on a loan from a related person, for example, a
relative, or a business entity in which you have an
ownership interest as defined by the tax law. And you
can't deduct if you are claimed as a dependent.
Tip: Where interest fails to qualify
under these tests, consider a home equity loan, interest
on which is generally deductible.
Cancellation of Student Loan. If certain requirements
are met, cancellations of student loans that are intended to
induce students to perform certain services do not increase
the student's gross income. This relief extends to certain
private programs, as well as government and public programs.
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President, Sullivan & Company