Tax Benefits for Higher Education

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A Planning Toolbox for CPAs

With annual college expenses running as high as $50,000, CPAs should be aware of the opportunities the IRS offers taxpayers for 2011. Although, dollar for dollar, credits are usually the preferred choice, CPAs should help taxpayers review the requirements and limitations of both credits and deductions and choose the method that will best minimize their tax liabilities.

Tax Benefits for Saving for Higher Education

IRC section S29 plans. Under IRC section 529, individuals may contribute to a qualified tuition program (QTP) on behalf of any beneficiary. Contributions made to a QTP are not deductible on the federal tax return, but the investment grows tax-free and the distributions to pay for the beneficiaries' qualified education expenses are tax-free to the beneficiary, as long as the distribution is not more than the beneficiary's qualified higher education expenses. This tax-free treatment was made permanent with the Pension Protection Act of 2006 signed by President George W. Bush.

Tuition and other expenses required to be paid to the educational institution for enrollment or a course - such as required student activity fees, special needs services, books, supplies, and equipment - are considered to be qualified education expenses. For 2009 and 2010, qualified higher education expenses also included expenses for computer technology and equipment or Internet access and related services. As of January 1, 2011, however, 529 plan withdrawals are not tax-free when paying for these technology costs. Expenses for room and board incurred by students who are enrolled at least half-time are considered a qualified education expense. But the amount of the room and board cannot be greater than the allowance for room and board, as determined by the educational institution, or the actual amount charged, if the student is residing in housing owned or operated by the educational institution. Insurance, medical, and other personal expenses are not considered qualified education expenses. Education credits or tuition deductions can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used in the tax calculations for the credits or deductions. If a beneficiary receives taxable distributions from both a QTP and a Coverdell Education Savings Account (ESA) in the same year, as discussed below, the postsecondary expenses must be allocated between the distributions.

Where is the income claimed? If any of the 529 plan distribution is taxable due to its being greater than qualified education expenses, the excess would be included as "other income" on Form 1040.

Who can claim the income? If any of the 529 plan distribution is taxable, the taxable portion would be reported on the beneficiary's tax return.

What expenses are eligible? Undergraduate and graduate studies qualify.

Exclusion of interest earned on education savings bonds. Under IRC section 135, a taxpayer may be able to cash qualified U.S. savings bonds and not include all or some of the interest earned on the bonds if the proceeds are used to pay qualified education expenses for the taxpayer and the taxpayer's spouse or dependent, and the taxpayer's modified adjusted gross income (AGI) is less than $85,100 (if single or head of household) or $135,100 (if married filing jointly or a qualifying widow). Qualified education expenses are tuition and fees paid to attend an eligible educational institution, including payments to a qualified tuition plan (529 plan) or to a Coverdell ESA. Education credits or tuition deductions can be claimed in the same year the beneficiary uses the qualified U.S. savings bonds to pay tuition expenses, as long as the same expenses are not used in the tax calculations for the credits or deductions.

Where is the exclusion taken? Form 8815, Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989, is used to calculate the education savings bond interest exclusion. …