Working through the Maze of Educational Tax Savings Available
Cooper, Robert H., The National Public Accountant
While there have always been tax savings available when paying for an education, the Taxpayer Relief Act of 1997 greatly increased both the types available and their complexity. New types of tax programs to assist those with educational expenses include:
* The HOPE Tax Credit
* Lifetime Learning Tax Credits
* Educational Savings Programs, which are 1. State Qualified Tuition Programs and 2. the use of an Educational IRA
* Use of Funds from a Retirement IRA
* Deduction of Interest on Educational Loan Interest
In addition to these, programs already available when paying educational expenses included:
* Employer Educational Assistance (extended for three years)
* Educational Business Expense Deduction for
1. the Self Employed, and for
* Series EE Savings Bonds
Most of the tax savings come with requirements your client must meet before receiving the tax benefit, limitations on what educational expenses are covered, and either reductions or phase-outs of the amounts deductible or of the tax credits.
These restrictions will be discussed for all of the educational tax savings programs available. This article will also discuss how to choose which program(s) to use.
Restrictions & Qualifications Common to Most of the Programs
Most of the educational tax savings programs are mutually exclusive, and so the best program should be chosen. While tuition and fees qualify as educational expenses for all the programs, other costs only qualify in certain programs.
Funds used for education must be reduced by the amount of funds that are received tax free, such as scholarships and veterans benefits before any deductions or credits are allowed. If a deduction is allowed, a credit or another deduction for using the same funds isn't allowed as well.
For the funds to qualify, they must be paid to qualified educational institutions. These institutions are generally those eligible to participate in the Department of Education student aid programs.
Educational Tax Credits
A centerpiece of the Taxpayer Relief Act of 1977 was the introduction of educational tax credits. While these can be of immense benefit to taxpayers, the alternative minimum tax can limit or even eliminate their benefit. They are also generally nonrefundable tax credits and aren't carried forward, so if the tax credits exceed the amount of income tax, any excess credit is lost.
There are two of these credits available, the HOPE credit, and the Lifetime Learning Credit. These are known as Code Section 25A credits. The HOPE and Lifetime Learning Credit cannot be used during the same tax year for the same individual.
The student must be either the taxpayer, the taxpayer's spouse, or the taxpayer's dependent. The taxpayer must be entitled to the personal exemption for the dependent. The credits are denied if the student has been convicted of a felony drug offense before the end of the tax year, or if a Married Filing Separate tax return is filed. In addition, the correct social security number of the student(s) must be on the tax return to claim either credit.
The HOPE Credit is available during the first two years of post secondary education for each student. It amounts to 100% of the first $1,000 in tuition and fees paid to the school, and 50% of the next $1,000 paid while the student qualifies.
To qualify for the HOPE Credit, the student must be at least a half time student during one academic period of the tax year at an accredited post-secondary educational institution.
The Lifetime Learning Credit may be claimed whether the courses are to improve job skills, for general education (but not for sports, games, or hobbies), or towards a degree. The credit is 20% of the first $5,000 ($10,000 after 2002) of qualified expenses per taxpayer return. This credit is available for expenses paid after July 1st of this year. …