What types of tax relief are available for costs of my children's higher education?
A wide variety of relief is available. In some cases you'll have to choose which to claim, based on what each is worth in your tax situation. There are tax exclusions, tax deferrals, tax credits, tax deductions, and relief from tax penalties.
You can't take two different kinds of relief for the same item. You can sometimes take one type of relief for one education item and another type for another item.
Some benefits have income ceilings that bar or limit the relief as taxpayer's income rises.
What's the education tax credit?
There are two types of education credit, Hope Credit and Lifetime-Learning Credit, and you must choose. Briefly: the Hope credit is for the first 2 years after high school, so it fits community college or the first 2 years of a 4 year college. It must be for at least half-time study. The annual credit ceiling is $1,800 per student in 2009 and 2008 (100% of the first $1,200, 50% of the next $1,200).
The lifetime learning credit fits any undergraduate or graduate study, but study less than half- time must be work-related. The credit ceiling is $2,000 (20% of expenses up to $10,000) per taxpayer per year.
Note: For students in Midwestern Disaster Areas, the 2008 Hope credit is 100% of the first $2,400 of qualified education expenses and 50% of the next $2,400 of qualified education expenses for a maximum credit of $3,600 per student. The definition of qualified education is expanded for students in Midwestern disaster areas. See IRS Publication Students in Midwestern Disaster Areas.
Do any tax planning considerations apply to the education tax credit?
For an academic period (quarter, semester, etc.) beginning in the first 3 months of a calendar year, you can pick which year to pay the expense and take the credit. That is, pay in December 2009 and take the credit in 2009 or pay in, say, February, 2010 and take the credit in 2010.
Your family may be able to save tax by foregoing the education credit and taking an available exemption for program distributions instead.
Do living expenses while in school qualify for tax relief?
Sometimes. Examples are for relief provided for Coverdell education expense accounts (Section 530 programs), for qualified tuition (section 529) programs, for withdrawals from traditional and Roth IRAs, and for student loans.
How does a Coverdell (section 530) program work?
An education IRA differs from other IRAs in the following ways:
Unlike other plans, 530 accounts may be used for primary and secondary education, including paying for room and board of children in private schools, and for computers and related materials whether or not away from home.
How can my family make best use of a Coverdell (Section 530) program?]
There can be a number of Section 530 accounts for any student. Various family members, such as grandparents, aunts and uncles, and siblings--and persons outside the family--can contribute to separate accounts for a student.
The original student beneficiary for the Section 530 account can be changed to another family member, such as a sibling--for example where the original beneficiary wins a scholarship or drops out.
Funds can be rolled over tax-free from one family member's Section 530 account to another's--for example, to avoid distribution when the first family member reaches age 30.
The education tax credit (where applicable) can be waived in favor of tax-free treatment for Section 530 account distributions.
What are qualified tuition programs?
These, also called Section 529 programs, are college savings programs established by almost every state, and some private colleges. You invest now to cover future college expenses, by contributing to a savings account or buying tuition credits redeemable in the future. Investments grow tax-free, and distributions to pay college expenses can also be tax-free. You may choose any state's plan, regardless of where you live.
How do Coverdell Section 530 plans and qualified tuition Section 529 plans differ?
In several major ways. Section 530 plans limit investment to $2,000 a year per student; 529 plans allow much larger investment. Section 530 plans allow wide choice of investment; 529 investment choices are limited and conservative. Section 530 is a single nationwide program; each 529 program is different. Though both are available for higher education, Section 530 can also be used for primary and secondary education. You are free to use both for higher education for the same student.
Can my traditional IRA be used for education?
Yes. The 10% penalty on withdrawal under age 59-1/2 won't apply, but ordinary income tax will apply to at least some of the withdrawal.
Can a Roth IRA be used for education?
Yes, generally under the same terms as traditional IRAs. Also, ordinary income tax is somewhat less likely, or may be smaller in amount, than with traditional IRAs.
What tax deductions are available for college education?
A $4,000 above the line deduction is allowed for qualified tuition expenses in 2009 and 2008.
Deduction up to $4,000 is allowed on if taxpayer's (modified) adjusted gross income is $65,000 or less ($130,000 or less on a joint return). If taxpayer's modified adjusted gross income is more than $65,000 but not more than $80,000 (more than $130,000 but not more than $160,000 on a joint return), deduction is allowed up to $2,000.
Business expense deduction is allowed, without dollar limit, for education that serves the taxpayer's business, including employment. Deduction is also allowed for student loan interest. A taxpayer may not take more than one deduction for the same item.
What tax benefits are available for Continuing/Adult Education for a sideline hobby?
Not much, if it's not part of a degree or certificate program, and not work-related, the limited deduction (up to $4,000 for tuition and fees) may be your only option. The deduction amount for 2009 or 2008 depends on your income. Some sideline interests might qualify for exclusion if paid for under an employer-provided education assistance program.
Can I deduct student loan interest?
Since personal interest is generally non-deductible, deductions must meet several tests:
- You must be the person liable on the debt and the loan must be for education only (not an open line of credit).
- Your income can't exceed $150,000 in 2009 ($145,000 in 2008) on a joint return or $75,000 in 2009 ($70,000 in 2008) on a single return; married couples filing separately cannot deduct.
You can't deduct if you're claimed as a dependent.
- Deduction ceiling is $2,500.
If I take a home equity loan to pay education expenses, can I deduct the interest?
Yes, as home equity loan interest, not as student loan interest. In this case there's no income ceiling on your deduction, and certain other student loan limits don't apply.
What tax treatment applies if my student loan debt is canceled?
Usually you're taxed on the unpaid loan balance. But tax can be waived if the debt is canceled because you participate in some approved government or other program.
What's the tax relief for education savings bonds?
Interest on redemption of Series EE bonds is tax-exempt if you redeem them in a year you have qualified education expenses. Exemption depends on the amount of your income in the year you redeem the bond.
Must I pay tax on my employer's payment or reimbursement of my education expenses?
Maybe not. Up to $5,250 can be tax free. Exemption can apply to graduate level courses.
Can I take tax deductions for education I pay for that helps me in my work?
Yes if it's to maintain or improve skills in your present job. No if it's to meet minimum requirements of that job, or to qualify to enter a new business. Employee's deductions are subject to the 2% floor on miscellaneous itemized deductions.