DAT Financial & Tax Service

Education Tax Breaks

A variety of tax laws make borrowing, saving and spending to go to college a lot cheaper. The following deductions and credits are generally not available for those filing married, filing separately.

Tuition Expenses

For 2011, if you are under income limits ($65,000 for singles and $130,000 for joint filers), you can deduct up to $4,000 in qualified college expenses (basically tuition and fees) regardless of whether you itemize your deductions on your return. If your modified AGI is between
$65,001 and $80,000 for singles and $130,001 and $160,000 for joint filers, you can deduct $2,000 in tuition and fees. The deduction is not allowed for married, filing separately or any taxpayer claimed as a dependent on another return.

Student Loan Interest Deduction

If you’ve borrowed money to pay for college or vocational school, up to $2,500 in interest may be allowed as a deduction -- above the line. Here again, you don’t have to itemize to get this benefit. Eligibility is phased out if income is between $60,000 and $75,000 for singles and $120,000 and $150,000 for joint returns.

Section 529 Plans

You can contribute to a Qualified Tuition Program (Section 529 Plan) without paying a gift tax. The amount you can contribute is limited to the amount necessary to cover expenses of the beneficiary, as determined by the plan. You get no federal tax deduction, but earnings come out tax-free if used to pay for qualified education expenses, including not only college tuition, but room and board and books, supplies and computer technology.

Anybody can contribute -- parents, aunts, uncles, grandparents, godparents. And there are no income limitations. You choose where the money is invested (within the options given by each state’s plan), unused dollars can be transferred to other family members, and the investment value is out of your estate.

Worst case? You can withdraw the money, pay the tax on the earnings plus a 10 per cent penalty. Even then, you’ve had the benefit of tax-deferral, if not exclusion. One other tip: Do some major comparison shopping. The fees on some plans are quite steep.

Education Savings Accounts

Contributions to these investment accounts aren’t deductible, but distributions for qualified education expenses also come out tax-free.

The big difference here is that it doesn’t have to be college tuition.
Elementary and secondary school expenses qualify. The annual contribution limit is $2,000.

There are income limits for contributions ($190,000-$220,000 for joint filers and $95,000 to $110,000 for others), but they can easily be avoided. Because there’s no requirement that anyone have earned income, if you can’t meet the income test, you can gift the money to the child and have the child make the contribution.

You can roll over unused dollars to other family members under age 30 without penalty.

Tax-free Employer Reimbursements for Education

Your employer can provide as much as $5,250 of education assistance for college or graduate school (including books and equipment) tax free.

IRA Withdrawals

Normally, if you take a withdrawal from an IRA prior to age 59 ½, you’re subject to a penalty of 10 per cent of that withdrawal, in addition to the normal tax.

But there’s an exception that allows you to avoid the 10 per cent penalty. If the money is used for qualified education expenses for you, your spouse, your kids or grandkids, there’s no penalty. You still must pay the tax. But you’ve escaped the 10 per cent penalty.

American Opportunity Tax Credit (Formerly Hope Credit)

A credit is a dollar-for-dollar reduction in tax. A $100 credit in the 25 per cent bracket saves $100. A $100 deduction in the 25 per cent bracket saves only $25.

For 2011, the Hope Credit is for your, your spouse’s, or your dependents’ first four years of postsecondary education.

You get a credit for 100 per cent of the first $2000, and 25 per cent of the next $2000 in qualified tuition, fees and books. The maximum credit for each student is $2500 per year.

This credit phases out between $80,000 and $90,000 in income (between $160,000 and $180,000 on a joint return). If your high income disqualifies you, consider whether your lower income “dependent” might qualify as independent. If so, and if the lower income student has potential tax, compare the net result of your loss of the dependency deductions and exemption to the tax savings from the credit.

The new credit is also 40% refundable.

Lifetime Learning Credit

This credit is for qualified education expenses that are ineligible under the Hope Credit.

The maximum credit here is 20 per cent of up to $10,000 in qualified tuition, fees and books, or $2,000 maximum.

This is a per-family, not per-person (as is the Hope credit) credit. But this credit covers graduate, as well as undergraduate expenses and is available for an unlimited number of years.

For 2011, the credit is phased out between $51,000 and $61,000 modified AGI ($102,000 and $122,000 for joint returns).

Savings Bond Interest Exclusion

Interest is excludable from income for the amount of qualifying expenses. This applies only to qualified Series EE bonds issued after 1989 or Series I bonds. The income phaseout is $106,650-$136,650 for joint filers and $71,100-$86,100 for others.

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