Magazine article The CPA Journal

Current Tax Incentives for Higher Education

Magazine article The CPA Journal

Current Tax Incentives for Higher Education

Article excerpt

The Economic Growth and Tax Relief Act of 2001 enhances the federal tax incentives for taxpayers that incur education costs, providing additional value for saving and paying for education.

Education IRAs

Old law. Under the old law, a taxpayer could make nondeductible contributions of up to $500 per designated beneficiary to education IRAS exclusively to pay for qualified higher education expense es such as tuition, fees, books, supplies, and equipment. If the beneficiary was at least a half-time student at an eligible educational institution, room and board, subject to limitations, was also a qualified higher education expense. An eligible educational institution was any college, university, vocational school, or other postsecondary educational institution eligible to participate in student aid programs administered by the Department of Education.

The $500 contribution limitation phased out for taxpayers with modified adjusted gross income (AGI) between $95,000 and $110,000 ($150,000 and $160,000 for joint returns). No contributions could be made to an education IRA of any designated beneficiary that had reached age 18. A 6% excise tax was imposed on contributions to an education IRA if contributions were made to a qualified state tuition program (QSTP) on behalf of the same beneficiary in the same year.

Distributions from education IRAs were not taxable as long as the funds were used for qualified higher education expenses. Distributions in excess of qualified expenses were subject to income tax plus a 10% penalty. The balance in an education IRA had to be distributed within 30 days after the date that the beneficiary reached age 30, or within 30 days of the date that the beneficiary died, if earlier. A Hope or Lifetime Learning Credit could not be claimed for an individual's education expenses if a tax-free distribution was also made from an education IRA for the same individual in that tax year.

New law. Effective for tax years beginring after December 31, 2001, a taxpayer can make nondeductible contributions of up to $2,000 per designated beneficiary. The phase-out range for joint filers increases to between $190,000 and $220,000.

Qualified education expenses have been expanded to include expenses for elementary and secondary school (kindergarten through 12th grade). Public, private, or religious schools are eligible. The costs of uniforms, transportation, academic tutoring, special needs services, supplemental items or services (including extended day programs), computer equipment, and qualified computer software now qualify as eligible expenses.

In the case of special needs beneficiaries, contributions can be made beyond age 18 and distributions do not have to be made by age 30. Taxpayers may now claim a Hope or Lifetime Learning Credit for a tax year and exclude amounts distributed from an education IRA (both the contributions and earnings portions) from income on behalf of the same beneficiary as long as the distribution is not used for the same educational expenses for which the credit is claimed.

The 6% excise tax is repealed for contributions made to an education IRA during the same tax year in which contributions are made to a QS on behalf of the same beneficiary.

The new law clarifies that corporations and other entities, including tax-exempt organizations, are permitted to contribute to education IRAs, regardless of their income during the year of the contribution.

Qualified State Tuition Programs

Old law. Under the old law, QSTPs, also known as section 529 plans or college savings plans, allowed taxpayers to contribute funds to pay for a designated beneficiary's future higher education expenses. Taxpayers could either contribute to an account set up to meet future qualified higher education ex es, or purchase tuition credits or certificates. Earnings accumulated tax-deferred and became taxable to the beneficiary when the funds were distributed to pay for the expenses. …

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