Over
the past several years, Congress has enacted many tax benefits for individuals
that pay qualified education costs for themselves or their family members. The
following are selected education tax breaks for your consideration as you
develop your 2004 tax planning strategies.
Coverdell
Education Savings Accounts. You can contribute up to $2,000 annually to a Coverdell education
savings account (formerly education IRA). This limit applies to the aggregate
contributions that may be made by all contributors to one or more Coverdell
education savings accounts (CESAs) established on behalf of any particular
beneficiary. Tax Tip.
You may make a contribution to CESA for 2004 by April 15th
of 2005. Your $2,000 contribution amount is phased out on a joint return as
adjusted gross income goes from $190,000 to $220,000 ($95,000 to $110,000 if
you are single). Planning
Alert! The IRS says a child
may make an
education
savings account contribution for himself or herself.
Thus, if the adjusted gross income of both the parents and the
grandparents exceed the limits, the child=s parent or guardian may wish to establish a
CESA with the child’s funds (e.g., funds in a Uniform Gift to Minors Act
account).
Although your contribution to a CESA is not deductible for tax purposes, you may make tax-free distributions from a CESA for the payment of qualified education expenses for elementary or secondary school education as well as for higher education expenses. This includes expenses for public, private, or religious schools (kindergarten through grade 12). Qualified education expenses include tuition, fees, academic tutoring, special need services, books, supplies, computer equipment (including related software and services), room and board, uniforms, transportation, and extended day programs (required or provided by the school in connection with the student’s enrollment or attendance at that school). Therefore, if the funds accumulated in the CESA are distributed for qualified education expenses, the earnings on the funds are tax free.
Section
529 Plans.
Earnings of a qualified state tuition plan (section 529 plan) may be
distributed tax-free for qualified higher education expenses. So, unlike
CESAs, K-12 education expenses should not be paid with section 529 plan funds.
However, there is no $2,000 per year limitation on the amount that may be
contributed to a section 529 plan and there are no income limits above which
the contribution may not be made. Instead, once the amount in a section 529
plan equals the amount necessary to fund 5-years of undergraduate education at
the highest cost institution in the state, no more contributions are allowed
to that particular beneficiary’s plan.
Many state tuition plans have limitations on total contributions of
$250,000 or more. So, if you wish
to accumulate funds for qualified college education expenses (tuition, fees,
and room and board), you should consider a section 529 plan.
Tax Tip. Many
individuals are using CESAs to save for private school education expenses and
setting up section 529 plans to fund college expenses. You may establish both
a CESA and a section 529 plan for the same individual.
Caution!
Contributions to CESAs and to section 529 plans are gifts to the
beneficiary of the account for gift tax purposes. However, the $11,000 annual
exclusion for gifts is available to offset these contributions for gift tax
purposes. Also, there is a special rule which allows you to consider the
amount of gifts to a CESA or a qualified tuition plan for a year as made over
five years. Therefore, it is generally not wise, from a gift tax standpoint,
to transfer the maximum amount allowed to a qualified tuition plan in one
year. However, by electing the 5-year rule, you could contribute $55,000
($110,000 if both husband and wife make contributions or elect split-gift
treatment) to a section 529 plan in one year and there should be no federal
gift tax on the contribution as long as no other gifts are made to the
beneficiary of the account for the current year and the next four years.
All
50 states now have state tuition plans. Also, most states allow non-residents
to invest in their plan. If you wish to review the state tuition plans offered
by your state as well as other states, please go to www.savingforcollege.com.
This web site summarizes the plans for every state.
Tax Tip. Please
call us before contributing to a state tuition program. We can help you decide
which plan best suits your needs. Also, some states allow a state
income tax deduction for contributions to qualified state tuition plans but
only if you contribute to that state’s plan. We can advise you if you get
additional state income tax benefits by contributing to your state’s plan.
Education
Expense Deduction. If you pay for
qualified higher education tuition and fees for yourself, your spouse, or your
dependents, you may qualify for an education expense deduction. This maximum
$4,000 deduction is available whether or not you itemize. For 2004, you are
allowed this maximum $4,000 deduction only if your adjusted gross income (AGI)
does not exceed $130,000 on a joint return ($65,000 if single).
If your AGI is between $130,000 and $160,000 ($65,000 and $80,000 if
you’re single) your maximum deduction drops to $2,000. Planning
Alert!
If you expect to take this deduction and your income is close to the
$130,000 or $160,000 limits ($65,000 or $80,000 if youre single), we should
discuss your situation and see if we can take steps to keep your income below
those thresholds for 2004. If you exceed the $160,000 or $80,000 limitation by
even $1, the entire deduction is lost.
IRS
Releases Final Regulations for Student Loan Interest.
You may deduct (whether or not you itemized deductions) up to $2,500 of
interest on qualified student loans. Your
deduction phases out as your adjusted gross income increases from $100,000 to
$130,000 on a joint return (from $50,000 to $65,000 on a single return).
In recently released regulations, the IRS says that loan origination
fees or late fees on qualified student loans will generally be deductible as
interest. The regulations also
say that any payment you make on the loan will first be applied to interest
that has accrued and remains unpaid before it will be applied to outstanding
principal. Furthermore, if
someone else pays your interest, the payment will be treated as a gift to you,
and you will then be treated as paying the interest yourself. Tax Tip.
If you paid any student loan interest in 2004, be sure to provide us
with Form 1098-E. This will help us determine your interest deduction for
2004.
HOPE
Education Tax Credit. If you pay post high
school education expenses for yourself, your spouse, or a dependent, you may
be entitled to a tax credit of up to $1,500 per student. The HOPE scholarship
credit is available only for two years of post-secondary education with
respect to any one student. Under the two-year rule, the credit is allowed for
a tax year if the student has not yet completed, before the beginning of
the tax year, the first two years of postsecondary education at an
eligible educational institution. For
a full-time student who enters college in the autumn, that means
that the credit is available for two of the first three calendar years the
student attends college. The credit phases
out ratably as your modified adjusted gross income increases from $85,000
to $105,000 on a joint return ($42,000 to $52,000 on a single
return). The HOPE credit equals
100% of the first $1,000 (and 50% of the second $1,000) of tuition and fees
required by the educational institution.
No credit is allowed for meals, lodging, transportation, or other
personal living expenses. Tax Tip. To get the full
$1,500 credit for 2004, you must pay tuition of at least $2,000 for the
student by December 31, 2004. If
tuition, for example, is $1,200 each semester, you must pay two semesters of
tuition in 2004 to get the full credit of $1,500.
If your child began college in August or September of 2004, you should
pay the $1,200 tuition for the spring semester of 2005 no later than
December 31, 2004 (payments after that date will not qualify for
credit during 2004). Tax
Tip! Unless more than one member of your family qualifies for either
the HOPE credit or the Lifetime Learning credit for 2004, the Lifetime
Learning credit will produce a larger tax benefit than the HOPE credit if
tuition and fees paid for 2004 exceed $7,500.
The
Lifetime Learning Credit. You may qualify for a
Lifetime Learning credit of up to $2,000. This credit equals 20% of the
first $10,000 of qualified higher education tuition and fees. The phase-out
rules for the Lifetime Learning credit are the same as those for the HOPE
credit discussed above. Unlike the HOPE credit, the Lifetime Learning credit
is for an unlimited number of years and can be used for graduate or
professional degrees (as well as undergraduate education). Also, the Lifetime
Learning credit limitation of $2,000 is per tax return not per student.
Caution! The Lifetime Learning credit is not available for any of
the education expenses of a student for 2004 if you take the HOPE credit for
education expenses for that same student on your 2004 return. Tax
Tip. In some situations, it may be better to claim the Lifetime
Learning credit for qualified expenses that would otherwise qualify for the
HOPE credit. For example, if a
freshman’s tuition is $10,000 in 2004, the Lifetime Learning credit would
give you a $2,000 credit compared to the HOPE credit of 1,500. Keep in mind,
however, that your total Lifetime Learning credit on your 2004 return
cannot exceed $2,000. By contrast, you may take a HOPE credit of up to $1,500
for tuition and fees for each family member who qualifies.
Planning
Alert!
If your income is more than $105,000 ($52,000 on a single return), you
do not qualify for the Hope credit or the Lifetime Learning credit. However,
the IRS says the student (e.g., your child) may claim the credits on his or
her return, provided you elect not to claim that child as a dependent on your
tax return (even if the child otherwise qualifies as your dependent). Of
course, since the HOPE and Lifetime Learning credits are non-refundable
credits, your child must have an income tax liability to utilize the credits
on his or her return.