For many parents it is has become very difficult to save for or pay for your child’s college education. Recognizing this, the federal government has stepped up its efforts to provide education tax benefits and incentives. While that is a good thing, understanding the myriad of education tax benefits and incentives out there can be frustrating and confusing to the average person. Lately, it seems every time you turn around there is some additional tax legislation in the area of education. Let’s review the various tax benefits and incentives available.
Hope Credit (American Opportunity Tax Credit)
Provides a tax credit for calendar years 2009 and 2010 of up to $2,500 for undergraduates in school more than half time. It can be claimed for all four years of undergraduate study. The first $2,000 of tuition costs and related fees (not room and board, however) are entitled to a 100% credit, while the next $2,000 of tuition costs (not room and board, however) are entitled to a 25% credit. Once your tuition costs exceed $4,000, there is no more Opportunity credit available. The credit is partially refundable. This means if you have no tax liability you are still eligible for a refundable credit of up to $1,000. If you are married parents with income of more than $160,000 your credit is phased out. If you are single, the credit begins to phase out when income levels exceed $90,000. This credit may be claimed by taxpayers who are subject to the dreaded alternative minimum tax, which is a good thing. You must reduce eligible education costs if you are receiving a scholarship, Pell grant, employer-provided educational assistance (tuition reimbursement) or distributions from 529 Plans.
Lifetime Learning Credit
Provides a nonrefundable tax credit of up to $2,000 for undergraduate, graduate and other tuition-related costs incurred during the calendar year. The first $10,000 of tuition costs and related fees (not room and board, however) are eligible for a 20% credit. You cannot claim this credit if you are also claiming the Hope Tax Credit in the same year for the same college student (no double dipping). This credit phases out in 2009 when your income level exceeds $100,000 (marrieds) or $50,000 (singles). You must reduce eligible education costs if you are receiving a scholarship, Pell grant, employer-provided educational assistance (tuition reimbursement) or distributions from 529 Plans.
529 College Savings Plans
When you contribute to a 529 Plan you do so with after tax dollars (net pay). The main tax benefit of 529 Plans is that earnings and gains are tax-deferred and if you make distributions from a 529 Plan to pay for qualified education expenses, then the earnings and gains are never taxed. One of the big advantages of 529 plans is that qualified education expense includes tuition, room and board. This means that even if your child gets a full scholarship for tuition, you can tap your 529 Plan to pay for his or her room and board. This is a big advantage over the Hope and Lifetime credits. You can contribute up to $13,000 for each child. This is a gift tax restriction. Anyone can contribute to your child’s 529 plan. Are you reading this grandparents? Each plan has an owner (typically the parent or grandparent) and one beneficiary (typically your child or grandchild). There is a provision that allows an acceleration of up to five years worth of contributions, or up to $65,000 in one year. This is an exception to the $13,000 gift tax restriction. If you make this election, you must file a gift tax return in the year of the contribution, however, there is no gift tax due, under this exception. You must reduce eligible education costs if you are receiving a scholarship, Pell grant or employer-provided educational assistance (tuition reimbursement).
Allows a non-deductible contribution using after tax dollars (net pay). Distributions from a Coverdell IRA (aka Education IRAs) are not taxed if such distributions are made for qualified education expenses. Qualified education expenses include tuition, room and board. The main advantage of Coverdell IRAs is the flexibility. Distributions may be made for elementary school, high school and tutoring costs, in addition to college expenses. This tax benefit phases out in 2009 when your income level exceeds $220,000 (marrieds) or $110,000 (singles).
For 2009, taxpayers may deduct up to $4,000 in tuition and fees expenses as an above-the-line deduction (i.e. deduction from gross income). This deduction is available even if you do not itemize. The deduction is phased out when your income level exceeds $130,000 (marrieds) or $65,000 (singles).
Student Loan Interest Deduction
Borrowers of federal and private education loans may deduct up to $2,500 in interest as an above-the-line deduction (i.e. deduction from gross income). This deduction is available even if you do not itemize. Available for undergraduate or post-graduate program loans. The deduction is phased out when your income level exceeds $150,000 (marrieds) or $75,000 (singles).
Distributions of principal (not earnings/gains) from Roth IRA accounts, open for five years or more, can be used to fund all college costs without any tax consequences.