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Tutorial 4
Federal tax incentives targeted to education
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[Excerpted from Savingforcollege.com’s Family Guide to College Savings]
One of the best ways to increase the affordability of your child’s education is to take advantage of federal tax breaks aimed at families saving and paying for college. These include the following:
Qualified Tuition Programs (529 plans)—Earnings grow tax-deferred and distributions are tax-free when used for qualified post-secondary education costs.
Coverdell Education Savings Accounts— Earnings grow tax-deferred and distributions are tax-free when used for qualified post-secondary education costs. May also be withdrawn tax-free for primary and secondary school expenses before 2011.
U.S. Savings Bonds—EE and I bonds purchased after 1989 by someone at least 24 years old may be redeemed tax-free when the bond owner or the bond owner's spouse or dependent pays for college tuition and fees. In 2008, the tax exclusion is phased out for incomes between $67,100 and $82,100 (between $100,650 and $130,650 for married taxpayers filing jointly). These income limits increase each year.
Individual Retirement Accounts—Early withdrawal penalties are waived when Roth IRAs and traditional IRAs are used to pay the qualified post-secondary education costs of yourself, your spouse, your children, or your grandchildren. (Taxes may still be due on the withdrawals, however.)
Hope Scholarship Credit—A parent may claim a tax credit for 100% of the first $1,200 and 50% of the next $1,200, of a dependent child’s college tuition and mandatory fees, for a maximum $1,800 annual tax credit per child. Students may claim the credit only if they are not claimed as a dependent on another person’s tax return. In 2008, the credit is phased out for incomes between $48,000 and $58,000 (between $96,000 and $116,000 for married taxpayers filing jointly). The credit is allowed only for students who are attending a degree program at least half-time and who have not completed their first two years of academic study before the beginning of the taxable year. It cannot be claimed in more than two tax years for any one student.
Lifetime Learning Credit—A taxpayer may claim a tax credit for 20% of up to $10,000 in combined tuition and mandatory fees for himself, his spouse, and his dependent children. This equates to a $2,000 tax credit. In 2008, the credit is phased out for incomes between $48,000 and $58,000 (between $96,000 and $116,000 for married taxpayers filing jointly). Claiming the Hope Scholarship credit described above means that you may not claim a Lifetime Learning credit for any of that student’s expenses in the same tax year. There is no requirement that the student be studying towards a degree or be enrolled at least half-time, and there is no limit on the number of years the credit may be taken.
Tuition and Fees—An above-the-line deduction (this means you do not have to itemize your deductions) for up to $4,000 of the college tuition and related expenses of yourself, your spouse, or your dependent was available in 2007 if your income was $65,000 or less ($130,000 or less if you are married filing jointly). For taxpayers with incomes between $65,000 and $80,000 (between $130,001 and $160,000 for married taxpayers filing jointly), the deduction limit was $2,000. The deduction was not available if a Hope or Lifetime Learning credit was claimed for that student's expenses for the same tax year. This deduction expired at the end of 2007, but congress may act in 2008 to extend it.
Deduction for Student-loan Interest—Up to $2,500 in student loan interest may be deducted above-the-line as long as the debt was incurred to pay the college costs for yourself, your spouse, or your dependent, while enrolled as a student at least half-time in a degree program. For 2008, the deduction is phased out for income between $55,000 and $70,000 (between $115,000 and $145,000 for married taxpayers filing jointly). A student claimed as a dependent may not take the deducation on his or her own return.
Tax-free Scholarships—Most scholarships and grants are tax-free if the recipient does not have to provide services in exchange for the award.
Tax-free Educational Assistance—Employers may pay and deduct up to $5,250 in college and graduate school costs for each employee under a Section 127 educational assistance plan. The education does not have to be job-related. The benefit is tax-free to the employee, but cannot be used to pay for an employee’s children or other family members.
For more information on tax incentives for education, see IRS Publication 970,
Tax Benefits for Higher Education, available at www.irs.gov.
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