Education Tax Breaks Can Help Pay for
College
Choose among tax-deferred savings plans, credits and
deductions.
The largest single expense item facing most parents of teen-aged or
younger children is paying for a college education or other post-secondary
professional training for their children. Putting money aside in
traditional savings accounts or mutual funds is good, but the earnings are
subject to tax every year and those funds typically are used to calculate
the family contribution factor in determining eligibility for college
financial aid. Identifying the best education tax breaks for this
year's tax preparation and future income tax planning can increase the
likelihood of reaching your family's financial and educational
goals.
Other family members, such as grandparents, may be interested in
helping out, but want some assurance that money they give will actually be
used for educational purposes. The tax code offers several
opportunities to build a college fund and, at the same time, reduce or
eliminate income taxes on at least some of that money.
You may use a combination of approaches including: Coverdell Education
IRA's, 529 Plans, the HOPE Credit and Lifetime Learning Credit, and the new
Higher Education Deduction.
The HOPE education credit and Lifetime Learning Credit have been available for several
years in the form of a credit on the parents' Form 1040 and are calculated
during each year's tax preparation process. These
credits area available for tuition and course-related fee expenses but do
not include charges for room and board. There are earnings
phase-outs based on adjusted gross income and some taxpayers are not
eligible for the credits.
The newly-renamed Coverdell Education IRA's used to have a $500
contribution limit per child, but that limit jumped to $2,000 for 2002 and
later years, which give the Education IRA more potential impact on a
family's income tax planning. The earnings on a Coverdell account are not taxable
when the funds are used for qualifying educations expenses, which include
tuition, fees, books, room and board and computers. A bonus with the
Coverdell account is that elementary and secondary education expenses are
also eligible (not just college). There is an income limit which
renders some taxpayers ineligible for the Coverdell. Normally, if
funds are withdrawn for non-education purposes, the withdrawal is taxed as
ordinary income and subject to a 10% penalty.
Code Section 529 plans are the newest savings vehicles for college
expenses. There are no income limits to worry about and the
contribution limits are quite generous -- up to $11,000 per child per
year, or up to $55,000 in one lump sum. The earnings are tax-free as
long as the account is used for qualified post-secondary education
expenses, which include tuition, fees, books and room and board.
Depending on your state's plan, a 529 contribution may generate a state
income tax deduction. Withdrawals for non-education purposes are taxed as ordinary income and
subject to an additional 10% penalty. If a family has substantial
sums that can be put aside for education, a 529 plan can be a major factor
in future income tax planning.
New for 2002 is a deduction against gross income for qualified
educations expenses (not room and board) for post-secondary courses.
The maximum deduction is $3,000 and is subject to limits based on the
adjusted gross income of the taxpayer. Each year during the tax
preparation process, a tax professional can plug college expenses in as an
education deduction and/or one or more education credits, to see which
approach provides the biggest tax break for each taxpayer.
Please see the College Savings Plan or
Education Credits & Deduction tables for some additional details. Only a tax professional can
precisely match a college savings program to your specific tax situation.
Which plan works for you and your family depends on individual and
family needs and tax situations. Also, if you move from one state to
another (or if a donor of the funds lives in a state different from the child
who will benefit from the plan), there could be other tax consequences.
Once you have reviewed the plans, please contact us. We will be
happy to prepare an education tax plan for you.
