IF YOU'VE GOT COLLEGE BOUND KIDS, we don't need to tell you that the cost of college these days is staggering. Fortunately, the governement has delivered some valuable tax breaks over the past few years to parents trying to foot those bills. Here's a rundown of what's available.
Hope Scholarship and Lifetime Learning Tax Credits
The 2009 American Recovery and Reinvestment Act expanded the Hope tax credit for tax years 2009 and 2010. Here's a summary of the changes:
- The credit is now called the American Opportunity Tax Credit
- The amount of the credit is larger: It matches 100 percent of the first $2,000 spent on qualified education expenses and 25 percent of the next $2,000. The maximum credit per student per year is $2,500
- It applies to expenses incurred during the first four undergraduate years of college, as opposed to just the freshman and sophomore years.
- It is available to people with higher incomes: $90,000 for single filers and $180,000 for joint filers.
- Course materials, including textbooks, will be added to the list of qualified expenses
The lifetime learning credit is less restrictive. It's mainly intended to help defray college costs after the first two years, when the Hope credit is no longer allowed. The Lifetime credit is available for an unlimited number of years and without any requirement to carry a certain course load. The credit equals 20% of tuition and fees up to $10,000, for a maximum annual credit of $2,000. This includes graduates courses as well.
Qualifying expenses for both the Hope and Lifetime credits include post-secondary tuition and fees for you, your spouse, and any other person claimed as a dependent on your tax return.
For 2009, both credits are phased out between adjusted gross income of $100,000 and $120,000 for joint filers; $50,000-$60,000 for unmarried taxpayers. You're completely ineligible if you're married and file separately from your spouse.
The $4,000 (or $2,000) Tuition and Fees Deduction
For 2009 you can deduct up to $4,000 of college tuition and fees paid for you, your spouse or any other person claimed as a dependent on your return. This is an "above-the-line" deduction, which means you don't have to itemize in order to take advantage of the break. However, the $4,000 figure is the annual maximum, regardless of how many students may be in your family. The other ground rules are as follows:
Student Loan Interest Deduction.
Thanks to more relaxed rules regarding the deduction of student loan interest, many folks who weren't previously able to take advantage of this tax break can now do so. If you qualify, you can write off up to $2,500 of annual college loan interest charges. The catch, however, is that this break is phased out if your modified AGI is too high.
Specifically, the 2009 phaseout range for unmarried taxpayers is between modified AGI of $60,000 and $75,000. For joint filers, the range is between modified AGI of $120,000 and $150,000.
Tax-Free Employer Education Reimbursements or Section 127 Plans.Should your employer agree to reimburse you for a class you take, up to $5,250 of that income is tax free. Even graduate-level courses qualify for employer reimbursements.
This break is available only for costs incurred by you, the employee. There's no AGI-based phase-out rule for this benefit.
Coverdell Education Savings Accounts (CESAs)
You can contribute up to $2,000 per year, which makes CESAs a nice little savings vehicle. This is especially true if you have several children (or grandchildren), since you can contribute a cool two grand annually to separate CESAs set up for each child (or grandchild). Annual contributions are allowed up until the account beneficiary (the college-bound child) turns 18.
If you are unmarried, your ability to make CESA contributions is phased out between adjusted gross income of $95,000 and $110,000. For joint filers, the phase-out range is between $190,000 and $220,000.
CESA earnings build up tax-free. Then the money can be withdrawn (also tax-free) to pay the account beneficiary's college expenses. Like contributions to Roth IRAs, CESA contributions are nondeductible, but the tax-free withdrawal privilege makes up for that. If the beneficiary doesn't attend college or doesn't incur enough expenses to exhaust his or her account, the balance can be rolled over tax-free into another family member's CESA.
You can also take tax-free CESA payouts to cover the account beneficiary's elementary and secondary school (K-12) costs. Eligible expenses include tuition and fees to attend private and religious schools, room, board, uniforms and transportation. You can also withdraw CESA money tax-free to pay costs to attend public K-12 schools. Eligible expenses include books and supplies; academic tutoring; computers, peripheral equipment and software; and even Internet access charges.
You have until April 15 (adjusted for weekends) of the following year to make your CESA contribution for the tax year in question. For example, you can make your 2009 CESA contribution as late as April 15, 2010.
State-Sponsored College Savings Plans ("Section 529 Plans")
State-sponsored college savings plans, often called "Section 529 Plans," can be a good deal since withdrawals to pay the account beneficiary's qualified college costs are tax-free. If you can afford to make substantial account contributions while your kids are still young, the tax advantages should sharply reduce the amount needed to fund their future college educations. One word of caution however: they have traditionally not had good rates of returns.
Most college savings plans now permit lump-sum contributions of well over $250,000. For gift-tax purposes, you can spread a large lump-sum contribution over five years. As you probably know, gifts made under the so-called $13,000 tax free gift rule won't trigger any federal gift taxes, nor will they reduce your federal gift- or estate-tax exemptions. But when contributing to a 529 plan, you can claim five years' worth of $13,000 exclusions upfront. This means a married couple can make a lump-sum payment of up to $130,000 (5 x $13,000 x 2 = $130,000) without any adverse gift tax consequences.
College savings plans typically offer several investment options, including equity mutual funds. Many plans also welcome out-of-state investors. They allow payouts for costs to attend any accredited college or university in the country. You should shop around to find the Section 529 college savings plan you like best. But keep in mind your in-state program may offer state tax advantages that tip the scale in its favor.
The tax benefits are available regardless of how high your income may be. In contrast, most of the other breaks covered in this article are phased out for high earners.
Warning: Don't confuse Section 529 college savings plans with Section 529 prepaid college tuition plans. They are both termed "Section 529 Plans" because both are permitted by the same Tax Code section. Here's the difference. Prepaid tuition plans allow you to lock in the cost to attend certain in-state colleges, but you gain nothing if your account turns out to earn more than the rate of inflation for costs to attend those colleges. In contrast, savings plans allow you to benefit when your account earns more than the rate of inflation for college costs. Of course, if it earns less, you pay the price.
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