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Tax Information With A Mother's Touch
Published by Eva Rosenberg, MBA, EA
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Save Thousands 
From Higher Education "T-Breaks!"
by Eva Rosenberg, MBA, EA.
Note: This article first appeared in Monday Magazine,  June 15-June 21, 1998, and is reprinted here with slight revisions.

I've long wondered why the United States Congress seemed to be doing everything it could to discourage educating our children and ourselves. Have you noticed that money for schools does not seem to be going into books, educational programs, or educators? In fact, many teachers these days are incapable of passing the very exams they are training their students to pass. Meanwhile, other countries' youth are getting excellent technical and creative training. Wouldn't you hate to be left in the dust?

And yet, there is cause for hope. Congress has wrought new wonders with Tax Reform Act (TRA) 97 so that you can get a tax break for higher education.

College Tuition Credit

The HOPE Scholarship Credit allows taxpayers to take a non-refundable credit of up to $1,500 per student/per year against federal income taxes. The credit is for the costs of tuition and fees paid for the first two years of post-secondary education in a degree or certificate program, including trade school. The funds may be spent on you, your spouse, or a dependent.

The HOPE Credit is only available for the first two years of college/trade school.

No deduction is allowed for expenses covered by scholarships and other grants that are not required to be included in your gross income when filing for the credit.

The Lifetime Learning Credit is 20 percent of the cost of qualified tuition expenses paid by the taxpayer for any year that the HOPE credit is not used. This credit is not effective until June 30, 1998 for expenses paid and education beginning after that date. But the Lifetime Learning Credit may be taken each year.

For tuition and fees paid between June 30, 1998 and prior to January 1, 2003, up to $5,000 of the tuition will qualify for the 20 percent Lifetime Learning Credit. For expenses paid after December 31, 2002, up to $10,000 of expenses will be eligible for the credit.

By the way, you can't get the credit and also take any itemized or Schedule C deductions for the same expenses.

Taxpayers may take advantage of both credits in the same year if there are several students in the household.

Naturally, the credits will not cover the costs of classes related to recreation, sports, hobbies, athletics, etc. unless that is the student's major course of study. (E.g. a phys. ed. Major planning to teach.)

Eligible educational institutions include colleges, universities, and others offering bachelor's, associate's and master's degrees or other post-secondary credential. They include vocational schools and any institution eligible to participate in the Department of Education student aid program.

Education

IRAs Tax Reform Act 213 creates a generous Education IRA, which permits up to $500 per year of contributions per beneficiary.

An education IRA is a trust or custodial account in the USA, with contributions made to that account until the beneficiary turns 18 years of age.

Note: This is not a deductible IRA, but the earnings can grow tax free.

A married couple may only contribute $500 to their child's Education IRA. But if they get divorced, they may each contribute $500 to that same child's IRA. (Think it's worth it?)

But grandparents, whose income does not exceed the MAGI (Modified Adjusted Gross Income) limits, may also contribute $500 to the child's Education IRA. So, the funds can add up.

The money grows tax free until it is taken out. All the money distributed must be used for qualified educational expenses.

In this case, it does include room and board expenses if the student is enrolled at an eligible educational institution at least on a half-time basis.

The rules about taking out and using the money are so complicated and involve so many penalties, be sure to do some advance planning with your Tax Professional before you devote any energy to this IRA. It can be good tool - in the right hands!

Qualified State Tuition Programs (QSTP)

These entities are established and operated by a state or designated agency. It permits people to make advance purchases of education by:
 
1)  Purchasing tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to a waiver or payment of qualified higher education expenses of that person, or
 
2) Making contributions to an account established for the sole purpose of meeting qualified higher education expenses of the designated beneficiary.

Receiving distributions from a QSTP will not prevent you from taking the HOPE and Lifetime Learning Credits. First apply the QSTP distribution to the educational expenses. Then, if there is any excess expense, you may apply for the credits.

Excess distributions from QSTPs are taken into income. There is no provision for a penalty.

Deduction for Student Loan Interest

Congress created an above-the-line deduction for interest on qualified educational loans. This means that even if you can't use itemized deductions, you can still reduce your income by the amount of interest you paid on your student loan. (Do you think they are trying to reduce the default rate on student loans?) The maximum deduction for each year is $1,000 in 1998; $1,500 in 1999; $2,000 in 2000 and $2,500 in 2001. (Sorry, but you can't deduct for 1997.) 

Penalty-free IRA Withdrawals for Educational Purposes.

A new benefit is that we are allowed to draw money from our IRAs to cover qualified educational expenses (including graduate level courses). You do have to include the amount you took out from the IRA into your income, but you will save the 10 percent early withdrawal penalty.

If you have redeemed any Series EE bonds and are excluding the interest on those bonds (see below), the amount of educational expenses must be reduced by the proceeds from the bonds. Then, you can apply the IRA withdrawals to the expenses. If you have drawn too much money, you will be subject to the 10 percent early withdrawal penalty.

U.S. Savings Bonds Proceeds

You know all about the Series EE bond interest? If the bond was issued after 1989, the interest income may be excluded from gross income as long as the bond proceeds were used to pay for the higher education of the taxpayer, spouse, or dependent.

Any expenses that are covered by the redemption of the bonds must be deducted before you figure allowable expenses for the HOPE and Lifetime Learning Credits.

Exclusion for Employer Provided Educational Assistance

The Tax Reform Act continues the tradition of the $5,250 gross income exclusion for educational purposes.

It is excluded from gross wages and from income of the employee. It still does not cover graduate level courses paid by the employer.

The top-heavy rules apply - no more than 5 percent of the amount paid or incurred by the company may be for the benefit of the class of individuals who are 5 percent owners or related parties.

The educational costs definition includes books, tuition, and fees, but not tools, supplies, room, or board. The classes must be directly related to your job, profession or business -- and they may not qualify you for a new career.

Are you confused by all the new options? Well, we've created a table to give you an overview. Remember, to use some of these, you can't use others. And you need to take the benefits in a certain order. If you receive tax free scholarships, you have to apply that money to your educational costs before any of these benefits kick in. It'll take some planning.

But, if you do it right, you could pocket several thousand dollars. And after all, that's what it's all about!
__________________________________
Copyright © 1998-2001, Eva Rosenberg
Reprinted and Revised 3/2/01

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