Tax Benefits For Educational Expenses
Since many of us have children ready, in or just out of college, I wanted to discuss the income tax deductions available for educational expenses.
The following is meant to be generally informative. This area of taxation law is both confusing and complicated. Please call or come in to see me with your questions. Or, if you really want to go straight to the source, down load Publication 970 at www.irs.gov.
Child & Dependent Care Credit:
A nonrefundable credit is allowed for a portion of qualifying child or dependent care expenses paid for the purpose of allowing the taxpayer to be gainfully employed.
How this relates to education expenses is that pre-school expenses incurred when both parents work qualify for this credit. Additionally, after school and summer programs may also qualify for children under age 13.
Also of note here, if your dependent or spouse is disabled and can not care for themselves, care costs may also be counted toward this credit.
Scholarships and Fellowships:
A scholarship or fellowship is tax free only if you are a candidate for a degree at an eligible institution and the money is used for qualified education expenses.
- Candidate for a degree – attend a primary or secondary school or are pursuing a degree at a college or university, or are attend an accredited educational institution that is authorized to provide a program that is acceptable for full credit toward a bachelor’s or higher degree, or a program of training to prepare students for gainful employment in a recognized occupation.
- Eligible institution – is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students.
- Qualified education expenses - are expenses for tuition and fees and course related expenses such as fees, books, supplies and equipment. These expenses must be required of all students in your course of instruction.
Other Types of Educational Assistance:
- Fulbright Grants – are generally treated as scholarships
- Pell Grants & Other Title IV Need-Based Grants - are generally treated as scholarships
- Payment to Service Academy Cadets - are fully taxable
- Veteran’s Benefits - received for education, training or subsistence are tax free
- Qualified Tuition Reduction - if provided by an eligible educational institution to one of its employees can be tax free.
There are two tax credits available in regards to educational expenses – the Hope Credit and the Lifetime Learning Credit.
Hope Credit:
Using the Hope Credit you may be able to claim credits up to $1,800 per eligible student for qualified education expenses. (Note the “may be able” phrase – there are income and other limitations and other qualifications that must be met for this credit.)
- Eligible student - an eligible student has to have not used the Hope Credit in the last two years, is either a freshman or sophomore, is at least a half-time student and does not have a felony drug conviction.
- Qualified education expenses - are tuition and certain related expenses paid for yourself, your spouse or a dependent.
Also regarding the Hope Credit – there is a whole bunch of small print, exceptions and provisos, so come to me with specific cases and questions.
Lifetime Learning Credit:
Lifetime learning credit qualifications are almost the same as those for the Hope Credit. Generally, a student eligible for this credit is not limited to freshmen and sophomores. This lack of limitation means that an eligible student with qualified education expense can always take the Lifetime Learning Credit of up to $2,000.
Student Loan Interest Deduction:
There is a special deduction allowed for paying interest on a student loan. This deduction hit a maximum of $2,500 in 2008.
- Student loan interest - includes interest and loan fees and origination fees.
- Qualified education expenses - are tuition and fees, room and board, books, supplies and equipment and other necessary expenses – such as transportation.
- Qualified loans – are from loan sources other than related personal or qualified employer plans.
Note the inclusion of loan fees and origination costs above. This is new and you may want to call your loan company and ask if your loan includes these costs. And, if these costs are big enough to warrant doing so, you may amend prior year’s tax returns and get a refund.
Cancellation of a Student Loan:
Normally cancellation of a debt is taxable to the amount of forgiven debt. However, cancellation of a student loan may not be income. To qualify for this exclusion the following two requirements must be present.
The loan must contain a provision that it may be cancelled if you work for a certain period of time in certain professions and for any of a broad class of employers. And, the loan must be from a qualified lender to assist the borrower in attending an eligible educational institution.
- Qualified lenders - include the federal, state or local government; certain tax-exempt public benefit corporations; an eligible educational institution (with certain provisions) or a Section 501(c)(3) organization
- Eligible Educational Institutions – are educational institutions that maintain a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance.
Tuition and Fees Deduction:
The Tuition and Fees Deduction can reduce the amount of your income subject to tax by up to $4,000. This deduction may be beneficial to you if you cannot take either the Hope or lifetime learning credit because your income is too high.
Generally, you can claim the tuition and fees deduction if all three of the following requirements are met:
You pay qualified education expenses of higher education
- You pay the education expenses for an eligible student, and
- The eligible student is either yourself, your spouse or a dependent for whom you claim an exemption on your tax return
Who can not take this deduction – those filing as married, filing separately; another person can take you as a dependent; your adjusted gross income is over $65,000 for singles or $130,000 for married filing jointly; you are a nonresident alien or you took the Hope or lifetime learning credit. (Note: The income levels are the starting amounts for a faze out of the deduction.)
Coverdall Education Savings Account (ESA):
You may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. Total annual contributions can not exceed $2,000 and the beneficiary must be under 18 years of age.
Note that the contributions are not deductible, however the account income is tax free.
Note also that the benefit applies not only to higher education expenses, but also to elementary and secondary education expenses.
Qualified Tuition Program (QTP) aka Section 529 Plans:
State may establish and maintain programs that allow you to contribute to an account for paying a student’s qualified education expenses. These Section 529 plans are often used by grandparents as a way to distribute fairly large amounts of their estates to their grandchildren. Talk to your financial advisor as too which state’s plan best suits your needs.
Note that you may contribute to a QTP plan and to a Coverdell ESA in the same year for the same beneficiary.
Education Savings Bond Program ( EE Bonds ):
One of the longest standing education expense benefits are the U.S. “EE” Savings Bonds. These bonds are purchased at half their face value and the interest accumulated tax free. If the bond proceeds are used for qualified education expenses and certain income limits are met, the accumulated income is not taxed. These bonds are safe and secure and may be purchased in small denominations. Ask the relatives to skip the usual birthday and Christmas presents, and instead give an “EE” bond instead. Sure it’s boring, however, just how may Barbies do your kids need anyway?
Employer-Provided Educational Assistance:
If you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits each year from your Form W-2 income. Note that the educational expenses must be incurred for the benefit of the employee, not their dependents. Ask your employer is these benefits are available. If your employer does not have a qualified plan, ask them to establish one. Not only are the employer contributions not taxed to you, your employer does not pay employment taxes or workman’s compensation insurance on the contribution amounts. These benefits are will worth the cost and effort for setting up the plan.
Business Deduction for Work-Related Education:
Work related education expenses can be deducted if you itemize your deductions, if an employee or file Schedules C or F, if self-employed and have qualified work-related education expenses.
Qualified Work-Related Education expenses must meet at least one of the following tests:
- The education is required by your employer or the law to keep your present salary, status or job.
- The education maintains or improves skills needed in your present work
However, even if the education meets one of the above tests, if is not qualifying if:
- The education expenses is needed to meet the minimum educational requirements of your job
- The education expense qualifies you for a new trade or business
