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COLLEGE SAVINGS 101

Tutorial - Federal tax incentives targeted to education

[Excerpted from Savingforcollege.comís 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. ESAs may also be withdrawn tax-free for primary and secondary school expenses.

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 owners, their spouses, or dependents pay for college tuition and fees. In 2014, the tax exclusion is phased out for incomes between $76,000 and $91,000 (between $113,950 and $143,950 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.)

American Opportunity Tax Credit—Through 2017, a parent may claim a tax credit for 100% of the first $2,000 and 25% of the next $2,000, of a dependent child’s college tuition and mandatory fees, for a maximum $2,500 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. The credit is phased out for incomes between $80,000 and $90,000 (between $160,000 and $180,000 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 four years of academic study before the beginning of the taxable year. It cannot be claimed in more than four 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 2014, the credit is phased out for incomes between $54,000 and $64,000 (between $108,000 and $128,000 for married taxpayers filing jointly). Claiming the American Opportunity 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.

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 2014, the deduction is phased out for incomes between $65,000 and $80,000 (between $130,000 and $160,000 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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