Diverse planning opportunities available under the TRA '97.

Need to advise clients on how to save for retirement or put their children through college? The Taxpayer Relief Act of 1997's (TRA '97) myriad education and retirement incentives provide numerous planning opportunities. The second part of this two-part article examines the array of strategic possibilities stemming from the changes made by the TRA '97 in these areas.

The Taxpayer Relief Act of 1997 (TRA '97), enacted Aug. 5, 1997, contains many provisions affecting individuals. Part I of this two-part article, published in the January 1998 issue, covered the TRA '97's investment, personal residence, family and miscellaneous provisions. This part explains the legislation's education and retirement tax incentives and highlights planning opportunities.

Education Incentives

Seven provisions provide education incentives. The TRA '97 created a labyrinth of new rules, phaseouts and, in some cases, choices for taxpayers between competing provisions. Overall, these provisions offer many interesting and useful ways to fund a child's education.

Planning opportunities: The provisions are not limited to use by parents of college-age children. Grandparents, workers, students and even persons unrelated to a child may all benefit from these new rules. Further, in many cases (e.g., Education individual retirement accounts (IRAs) or qualified state tuition programs), the tax benefit can be enhanced substantially by planning years in advance of the expenditures.

Included among the education incentives are the "Hope Scholarship" Credit, the "Lifetime Learning" Credit, the Education IRA and the deduction for education loan interest. These incentives are described in the table on pages 110-111.

A taxpayer may claim either the Hope Scholarship Credit, the Lifetime Learning Credit or the Education IRA distribution exclusion for any one student in a given year. However, a student may waive the tax-free treatment of an Education IRA distribution in any tax year so that he or his parents may claim a Hope Scholarship Credit or Lifetime Learning Credit for expenses paid in the same year in which Education IRA distributions are received.

Planning opportunities: Before making any Education IRA withdrawal to cover education costs, the practitioner, the parents and/or grandparents should analyze whether the tax-free treatment waiver exceeds the loss of a portion of the credit. Also, the term "Education IRA" is a misnomer, because the account has nothing to do with retirement and does not affect an otherwise eligible taxpayer's ability to contribute to a regular or Roth IRA (discussed below).

Hope Scholarship and Lifetime Learning Credits; Penalty-Free IRA Withdrawals

In determining expenses eligible for the Hope Scholarship and Lifetime Learning Credits and penalty-free IRA withdrawals, Secs. 25A(g)(2) and 530(b)(2) provide that "qualified" tuition is reduced by amounts (1) excludible from gross income (e.g., Sec. 117 tax-free and Pell Grant scholarships, Sec. 127 employer assistance or tax-free distributions from Education IRAs) or (2) deductible as expenses (e.g., Sec. 162 business expenses); no reduction is required for a gift, bequest, devise or inheritance under Sec. 102(a). Expenses paid from a student's earnings, a loan, a gift, an inheritance or personal savings (including savings from a qualified state tuition program) qualify in calculating the credit and eligible withdrawal amount. According to Sec. 25A(g)(6), the Hope Scholarship and Lifetime Learning Credits are not available to taxpayers married filing separately.

Planning opportunity: For both the Hope Scholarship and Lifetime Learning Credits, Sec. 25A(g)(4) provides that expenses must be paid for classes beginning during the tax year or during the first three months of the following tax year (i.e., prepayments are generally not permitted). However, taxpayers can prepay in 1998 for academic periods beginning in January through March 1999 and claim the credit on their 1998 returns. The Lifetime Learning Credit may also be available for clients considering career changes.

Education IRAs

The Education IRA is a trust or custodial account created exclusively for the purpose of paying qualified higher education expenses (defined in Sec. 530(b)(2)).

Planning opportunities: There is no requirement that the contributor be related to the beneficiary and no limit on the number of beneficiaries on behalf of whom contributions can be made; thus, this provision might be of interest to taxpayers with income below the phaseout limit (see the table on page 110). Because the contributor is not required to have a minimum adjusted gross income (AGI) (unlike with a regular IRA), students can contribute on their own behalf even if they have little or no income.

Multiple Education IRAs could be created for one beneficiary, but the Sec. 530(b)(i)(A)(iii) limit on contributions for a single beneficiary is $500 in any one tax year. Under Sec. 530(d)(4), aggregate contributions for the benefit of a particular child in excess of $500 for a year constitute excess contributions. If the excess contributions (and any earnings thereon) are not withdrawn from the child's account(s) before the due date of the return for that year, they are subject to a 6% excise tax each year such excess remains in the account.

Assuming a maximum annual contribution of $500 is made each year from birth on the beneficiary's birthday and the account earns 8% annually, the account would be worth approximately $22,300 by the beneficiary's 18th birthday.

Planning opportunities: Transfers and rollovers of account balances from an Education IRA benefiting one beneficiary to an Education IRA benefiting another beneficiary (and redesignations of the named beneficiary) are permitted under Sec. 530(d)(5) (with no transfer tax consequences, if the beneficiaries are in the same generation) if certain conditions are met. The new beneficiary must be a member of the original designated beneficiary's family (i.e., the designated beneficiary's ancestor, spouse, lineal descendant, lineal descendant of the spouse or of a parent of either or the spouse of any such lineal descendant). In addition, the transfer or rollover must occur before the original beneficiary reaches age 30. The $500 annual contribution limit to Education IRAs does not apply to rollover contributions.

Example 1: X is 22 and graduating from college in 1998 with a $3,000 balance in an Education IRA. In 1998, X can rollover that balance to Y, his 15-year-old sister, tax-free; Y's parents may additionally contribute $500 in 1998 to Y's education IRA.

Rather than rolling over funds from one Education IRA to another, the account name can simply be changed from one designated beneficiary to another tax-free, provided the account's terms permit a change in the designated beneficiary and the new beneficiary is a member of the previous beneficiary's family. Notice 97-57(1) provides that entities already approved to serve as nonbank trustees and IRA custodians are automatically approved to serve the same function for Education IRAs. In addition, entities other than banks or previously approved nonbank IRA trustees or custodians may request such approval.

Student Loan Interest Deduction

After the TRA '97, interest is deductible for the first 60 months of a student loan (see the table above). Original education loans and refinancings of such loans are treated as one loan in determining the 60-month deduction period. Interest payments are deductible for pre-affective date loans to the extent of the remaining portion of the 60-month period. The deduction is not affected if the loan is federally guaranteed or subsidized. Additional types of lenders can forgive student loans without triggering taxable income to students who fulfill certain public/community service requirements (rather than repaying the loan with cash).

Planning opportunities: A student who continues to pay interest on a student loan and meets the other eligibility requirements may be able to claim the interest deduction for payments made in a year when the student is no longer claimed as a dependent on the parent's return.

Employer-Provided Educational Assistance

The exclusion of up to $5,250 per year under Sec. 127(d) of amounts paid by an employer for educational assistance was extended by TRA '97 Section 221. Neither the Hope Credit nor the Lifetime Learning Credit may be claimed for a student for a year in which an employer pays all of the student's qualified tuition and related expenses; however, the exclusion does not apply to reimbursements for graduate courses (e.g., law or business school).

Planning opportunities: Even without the exclusion, all employer-provided educational assistance (even if for graduate courses) is nontaxable if the taxpayer can establish that the expenses would have been deductible job-related expenses (i.e., the education maintains or improves skills required for the employee's current job or satisfies certain employer-imposed conditions for continued employment) had the taxpayer paid for it.

IRS Guidance

Notice 97-53(2) states that TRA '97 Section 203, which provides exceptions to the 10% penalty tax for early withdrawals (i.e., before age 59 1/2) from regular IRAs for higher education expenses, is effective for such distributions made after 1997. According to the notice, taxpayers who want to use IRA finds for students enrolling in the 1997-1998 academic year, can withdraw funds without penalty only for the semester (or trimester, quarter or other academic term designated by the educational institution) beginning in January 1998, but only if the IRA distribution is made after 1997, for expenses paid after 1997. For this purpose, an academic period begins on the first day of classes, and does not include periods of orientation, counseling or vacation.

Notice 97-60(3) explains, in question-and-answer format, all seven higher education tax incentives contained in the TRA '97, including the eligibility requirements and other mechanics.

Planning opportunities: Additional IRS guidance on the education incentives and other TRA '97 provisions are available on the IRS Website at http://www.irs.ustreas. gov/hot/taxlaw.html. Additionally, the Department of Education's Website at http://www.ed.gov/proginfo/SFA/ StudentGuide has information on student aid and affording college.

When practitioners consider the various options available to clients, they should review first the phaseout levels to eliminate those incentives for which the client's modified adjusted gross income (AGI) does not qualify (see the table on pages 110-111 for the various phaseout ranges). It may be possible to implement income-shifting strategies for clients to defer income or accelerate losses into a year in which sufficient expenses will be paid to qualify for a particular incentive. The Education IRA phaseout applies to the contributor in the year of contribution; the income-shifting techniques need to be considered in that context.

An examination of the table on pages 110-111 reveals that tuition and fees and qualify for the Hope Scholarship Credit, tuition and fees qualify for the Lifetime Learning Credit, and tuition, fees, books, supplies, equipment and certain room and board qualify for the Education IRA. In addition, the Lifetime Learning Credit and penalty-free IRA withdrawals cover graduate courses, while the Hope Scholarship Credit and employer-provided educational assistance exclusion are limited to undergraduate education. Also, the credits and education loan interest deduction cover only the taxpayer, spouse and dependents, while the Education IRA covers any beneficiary under age 18, including nonrelatives. Another issue is whether the student attends school at least half-time, which is important for purposes of the Hope Credit and the room and board expenses of the Education IRA, but not for the Lifetime Learning Credit. A major issue is who will claim the student as a dependent; this could become a bargaining chip in divorce negotiations. Generally, the parent paying the tuition should also claim the dependency exemption; this issue could be important not only in minimizing the parents' and the student's taxes, but also for financial assistance purposes.

Retirement Incentives

Sen. William Roth (R-Del.), Chair of the Senate Finance Committee, has long been an advocate of expanded IRAs. The TRA '97 contains major changes and expansions in the IRA and retirement savings options available to taxpayers, including a new type of IRA--the Roth IRA. The table at left compares the various IRA options and benefits now available.

Roth IRAs

Under TRA '97 Section 302, adding Sec. 408A, starting in 1998, taxpayers may make an annual nondeductible contribution of up to $2,000 (or 100% of compensation, if less) to a tax-exempt Roth IRA. If the taxpayer is married, up to $2,000 per spouse may be contributed, provided that the couple's combined compensation at least equals the amount contributed. The $2,000 contribution limit is phased out at AGI between $150,000 and $160,000 joint (between $95,000 and $110,000 single)--a significantly higher income phaseout level than for the deductible IRA; thus, many clients who previously did not qualify for a deductible IRA may qualify for a Roth IRA. Taxpayers who maintain Roth IRAs for at least five tax years can withdraw the funds income tax-free if they have attained age 59 1/2 or the distribution results from their death or disability or is for first-time homebuyer expenses. Withdrawals from a Roth IRA before age 59 1/2 are tax- and penalty-free to the extent the withdrawal is of contributions, not accumulated earnings. No mandatory distributions from any Roth IRA are required after age 70 1/2.

Planning opportunities: Because there are no age limits on contributions and no minimum distribution requirements, significant amounts can be accumulated (and will continue to accumulate) on a tax-free basis for the benefit of future generations. However, such accumulations are subject to estate tax.

Taxpayers with AGI under $100,000 can convert a regular (deductible or nondeductible) IRA to a Roth IRA; such conversions are treated as deemed distributions from the regular IRA, resulting in income recognition. However, if the conversion occurs in 1998, the income is spread over four years. The 10% early withdrawal penalty tax (for those under age 59 1/2) does not apply to conversions to a Roth IRA, even conversions after 1998. Taxpayers can withdraw from a Roth IRA the amount needed to pay the tax stemming from the conversion in each of the four years over which the payment is spread.

Planning opportunities: The benefit of the conversion and future tax-free accumulation is maximized if the taxes due on the deemed distribution of the existing IRA are paid with non-IRA funds.

Depending on the assumptions used (which differ in every case), many models will show that the benefits of tax-free build-up in a Roth IRA often outweigh the cost of having to pay the tax early on the deemed distribution from the regular IRA. This is particularly true because contributions to the Roth IRA may be able to continue indefinitely (if the ongoing AGI limitations are met) and there are no minimum withdrawal requirements.

Because only 1998 conversions are eligible for the four-year spread (a substantial incentive to convert in 1998), and only taxpayers with AGI less than $100,000 can make the conversion, 1998 becomes a crucial planning year to (1) determine whether clients are likely to benefit from conversion, and if so, (2) attempt to structure their financial affairs so that AGI remains under $100,000. Obviously, the earlier in the year this planning process begins, the better.

There are several ways to convert to a Roth IRA without actually taking a distribution. An individual can do so by notifying the IRA trustee when changing IRA trustees through a rollover or a trustee-to-trustee transfer. However, if only part of an IRA balance is converted to a Roth IRA, the Roth IRA amounts may have to be held separately.

Planning opportunities: Aside from the conversion decision, in general, for eligible taxpayers, the Roth IRA offers an excellent opportunity to invest for long-term growth on a tax-free basis. The decision of which kind of IRA is best will be greatly affected by the assumed tax brackets in the years of contributions and withdrawals (and the fact that withdrawals from a Roth IRA are never required).

Clearly, taxpayers who are currently in a low tax bracket should benefit from the Roth IRA, because the forgone deduction is (relatively speaking) a smaller price to pay for tax-free growth; students and young employees might fall into this category. in fact, the Roth IRA may be a good way to save for a first home, because penalty-free withdrawals are permitted for first-time homebuyer expenses.

However, even taxpayers who are currently in a higher marginal bracket (and therefore, have more to lose from the forgone IRA contribution deduction) may ultimately realize a greater benefit from a Roth IRA due to the potential for continued contributions after age 70 1/2, and/or the lack of a minimum withdrawal requirement.

One can begin to appreciate the complexity of the analysis necessary to properly advise clients when the innumerable factors are considered, some of which are:

* The tax bracket when contributions will be made.

* The tax bracket when withdrawals will be made.

* Whether contributions are (or will be) made after age 70 1/2. When (if ever) withdrawals will be needed.

* The growth rate of the account.

* The life expectancy and marital status of the account holder.

* Whether IRA funds will be needed within five years of contribution.

* AGI in future years (there are different AGI thresholds for regular IRAs and Roth IRAs, such that one or the other may not be an available option in some years).

* The availability of other retirement savings programs (e.g., Sec. 401 (k) plans).

* Future law changes, etc.

Because there are so many factors to be considered for so many years into the future, one could argue that, in many cases, the analysis is nothing more than guesswork. Perhaps the safest course of action in such cases is simply to divide the contributions between regular and Roth IRAs, obtaining a small tax benefit now with some tax-free accumulation. In any event, there are numerous software programs available to help practitioners analyze the choices.

Finally, the House version of the Tax Technical Corrections Bill of 1997(4) addresses a glitch in the TRA '97 that allowed taxpayers with deductible IRAs to convert to a Roth IRA and make penalty-free withdrawals from it while Liking advantage of the four-year spread.

Deductible IRAs

For 1997, under Sec. 219(g), the $2,000 regular IRA deduction is phased out ratably if either the taxpayer or spouse is an active participant in an employer-sponsored retirement plan and AGI is $40,000-$50,000 joint ($25,000-$35,000 single). However, starting in 1998,TRA '97 Section 301 amends Sec. 219(g) to increase the phaseout range to $50,000-$60,000 joint ($30,000-$40,000 single); this increases annually until 2007, when the phaseout range is $80,000-$100,000 joint ($50,000-$60,000 single). Also starting in 1998, for married taxpayers with AGI of less than $150,000, a spouse not covered by an employer plan can contribute to a regular IRA, even if the other spouse is so covered; the regular IRA deduction phases out between $150,000 and $160,000 of AGI.

Planning opportunities: Because more clients who are active participants (or whose spouses are) may now qualify for deductible IRAs, clients with moderate AGI who may not have previously qualified for deductible IRAs should consider this option (or, perhaps, a Roth IRA). As before, maximum contributions (up to $10,000 in 1998) to Sec. 401(k) plans should be encouraged.

Nondeductible IRAs remain permissible for those under age 70 1/2 with earned income; they provide a universally available option for tax-deferred investing for those not eligible (because of AGI limits) for either a Roth or a deductible IRA. Nondeductible IRAs remain available regardless of eligibility in an employer-provided retirement plan.

Example 2: Y, who is in the 28% tax bracket, invests $100 a month for 20 years in an account with an 8% annual return. A taxable account will yield approximately $32,500; an IRA (before income taxes payable on any taxable withdrawals) will yield approximately $59,300.

Penalty-Free IRA Withdrawals

In addition to penalty-free withdrawals for education expenses (discussed above), Sec. 72(t), as amended by TRA '97 Section 303, allows penalty-free IRA withdrawals for certain home purchases. The aggregate distributions for a first-time home purchase cannot exceed a lifetime cap of $10,000 per home per eligible buyer.

Planning opportunities: A parent with two children can withdraw as much as $10,000 penalty-free for each child who separately buys a first home. This provision provides an additional means of saving for the first home purchase. For clients or their children contemplating buying a home (even if not their first home), this penalty-free IRA withdrawal opportunity should not be overlooked. Sec. 72(t)(8)(D)(i) defines a qualified first-time homebuyer as someone who has had no ownership interest in a residence during the past two years; thus, many home purchasers may qualify for this exception even if the home is not literally the first. In addition, home-purchase funds do not have to come from the home buyer's IRA alone--they can come from the IRA of the parents, a spouse, grandparents or an ancestor.

Legislative Outlook

Before the ink was completely dry on the TRA '97, Congress began to talk about a 1998 tax bill. While various fundamental tax reform plans, from a flat tax to a national sales tax, are still being advocated by key members of both parties (and may have gained attention after the Senate hearings on IRS problems and the IRS restructuring legislation), specific Code provisions are being discussed as possibilities for revision in 1998. They include: modifications to individuals' alternative minimum tax (AMT) (in response to the realization that millions of taxpayers will soon be subject to AMT if no changes are made), marriage penalty and innocent spouse relief, extension of expiring provisions, expansion of the new Education IRA and technical corrections. There is also considerable discussion among Republicans who advocate the repeal of the estate and gift taxes. With all of these areas already under consideration, and given that 1998 is an election year, it would not be surprising to see significant tax legislation this year.

Conclusion

In general, Congress traded simplicity for a variety of new, complex incentives; consequently, the TRA '97 provides many opportunities for practitioners. As mentioned in Part I, the spread between ordinary income and long-term capital gains rates, for example, is greater now than it has been since 1986, providing fertile ground for planning in 1998 and beyond.

For practitioners and taxpayers alike, the new education and retirement incentives add yet another level of complexity, particularly in deciding among the available choices. However, the tax savings opportunities (including dollar-for-dollar credits) can be quite powerful, especially over time; hence, they need to be reviewed and considered for clients. Because most of the TRA '97s provisions are effective in 1998, practitioners should begin discussing these options with clients during the current filing season. The conversion from a regular to a Roth IRA should definitely be analyzed in 1998; this is the only year in which a four-year spread is permitted on the recognition of the deemed distribution. Planning will also be required for years to come, as taxpayers seek assistance in finding the optimal methods of funding both education and retirement.

(1) Notice 97-57, IRB 1997-43, 19.

(2) Notice 97-53, IRB 1997-40, 6.

(3) Notice 97-60, IRB 1997-46, 8. For a more detailed discussion of Notice 97-60's effect on the various incentives, see Tax Clinic, "IRS Issues Guidance on Education Tax Incentives," p. 88, this issue.

(4) HR 2645.

RELATED ARTICLE: EXECUTIVE SUMMARY

* Seven TRA '97 provisions assist with or provide incentives for education.

* The TRA '97 contains major changes and expansions in the IRA and retirement savings options available to taxpayers.

* Specific areas of the Code are already being discussed as possibilities for revision in 1988.

RELATED ARTICLE: Education Tax Incentives

Incentive                                Description

Hope Scholarship Credit      Nonrefundable $1,500 tax credit per
TRA '97 Section 201,         student for the first two years of
 adding Sec. 25A             postsecondary qualified tuition and
                             related expenses (QTREs) (i.e.,
                             tuition and fees, excludes books,
                             room and board, equipment, meals,
                             lodging, transportation and
                             excludable assistance/scholarships).
                             The credit is 100% of the first
                             $1,000 of QTREs and 50% of the
                             second $1,000 of QTREs. When a
                             child is claimed as a dependent
                             on a parent's return, any QTREs
                             paid by the child during the year
                             are treated as if the parent had
                             paid them; these expenses are
                             included in calculating the
                             parent's credit. The parent may
                             claim the credit on his own
                             return even if the child files a
                             return.

                                             or

Lifetime Learning Credit     Nonrefundable $1,000 (increases
TRA '97 Section 201 (a),     to $2,000 in 2003) tax credit
 adding Sec. 25A             per return for an unlimited
                             number of years of QTREs
                             (including undergraduate and
                             graduate school, professional
                             degrees and courses to acquire
                             or improve job skills).

                                             or

Education IRA                Withdrawals are tax-free to the
TRA '97 Section 213,         extent of the beneficiary's
 adding Sec. 530             qualified higher education expenses
                             (QHEEs) during the year of
                             withdrawal (i.e., postsecondary
                             tuition,fees, fees books, supplies,
                             equipment and certain room and board
                             if the student is at least
                             half-time); if the withdrawal
                             exceeds QHEEs, the beneficiary
                             pays income tax and a 10% penalty
                             on the earnings portion of the
                             withdrawal.

                                             and

Higher Education Loan        $1,000 above-the-line deduction
 Interest Deduction (a),     for qualified interest on
 adding Sec. 221             student loans (including
                             refinancings). Deduction is capped
                             at $1,000 in 1998, $1,500 in 1999,
                             $2,000 in 2000, and $2,500 in
                             2001 and future years. The loan
                             must be used to pay QHEEs for a
                             dependent enrolled at least
                             half-time in a program leading
                             to a degree (including certain
                             graduate degrees).

                                             and

Penalty-free IRA             10% early withdrawal penalty
 Withdrawals for Education   (if pre-age 59 1/2) is waived
 Expenses TRA '97 Section    on early withdrawals from regular
 203, amending Sec. 72(t)    or Roth IRAs used for QHEEs of
                             the taxpayer, spouse, or their
                             child or grandchild if the
                             student is enrolled at least
                             half-time (including for
                             graduate courses). (Penalty
                             waiver also applies to home
                             acquisition costs of a
                             first-time homebuyer.)

                                             and

Employer-Provided            $5,250 of employer-provided
 Educational Assistance      education assistance for
 Exclusion                   undergraduate courses can be
TRA '97 Section 221,         excluded per year.
 amending Sec. 127(d)

                                             and

Qualified State Tuition      Distributions or earnings from
 Program                     a qualified state tuition
TRA '97 Section 211(b),      program may be excluded by the
 amending Sec. 529(c) and    contributor to (or a beneficiary
 (e)                         of) such program. Contributions
                             or purchases of tuition credits
                             or certificates provide the student
                             a waiver or payment of QHEEs.
                             Tax-free rollovers and
                             transfers of credits or account
                             balances ore allowed to family
                             members (i.e., children, siblings,
                             nephews and nieces, certain
                             in-laws and any spouse of such
                             persons).

Incentive                       Eligibility/Phaseout/Limits

Hope Scholarship Credit      Credit phases out at modified AGI of
TRA '97 Section 201,         $40,000-$50,000 single/
 adding Sec. 25A             $80,000-$100,000 joint. For expenses
                             paid after 1997 (in tax years ending
                             after 1997), for education provided
                             in academic periods starting
                             after 1997. For expenses of the
                             taxpayer, spouse or dependent.
                             Student must be at least half-time.
                             Educational expenses involving
                             sports, games, student activities
                             or hobbies are not QTREs unless
                             such course or education is part
                             of a degree program. No credit is
                             allowed if the student is convicted
                             of a felony drug offense before
                             the end of the tax year. A dependent
                             on another person's (e.g.,
                             parent's) return may not claim
                             a Hope Scholarship Credit on his
                             own return. Not available if
                             married filing separately.

Lifetime Learning Credit     Credit phases out at modified AGI
TRA '97 Section 201 (a),     of $40,000-$50,000 single/
 adding Sec. 25A             $80,000-$100,000 joint. For expenses
                             paid after June 30, 1998 for
                             academic periods starting after
                             that date. For expenses of taxpayer,
                             spouse or dependent. Not available
                             if married filing separately.

Education IRA                Nondeductible contribution of $500
TRA '97 Section 213,         per year per beneficiary (under age
 adding Sec. 530             18) beginning in 1998; phases out
                             at modified AGI of $95,000-$110,000
                             single/$150,000-$160,000 joint. No
                             contributions (unless treated as
                             excess contributions) are allowed in
                             the year contributions are made to
                             a qualified state tuition program
                             for the student. if the funds are not
                             used for educational expenses before
                             the beneficiary is age 30, the
                             balance must be distributed and the
                             earnings taxed to the beneficiary,
                             plus a 10% penalty.

Higher Education Loan        Deduction phases out of modified AGI
 Interest Deduction (a),     of $40,000-$55,000 single/
 adding Sec. 221             $60,000-$75,000 joint. For payments
                             due and paid after 1997. For interest
                             on loans of the taxpayer, spouse or
                             dependent. Only available for
                             interest paid on loans during the
                             first 60 months that payments are
                             required. No deduction is allowed
                             to a person eligible to be claimed
                             as a dependent on another person's
                             return for the year. Not available
                             if married filing separately.

Penalty-free IRA             Withdrawals are subject to income
 Withdrawals for Education   tax if from a regular IRA (but not
 Expenses TRA '97 Section    if from a Roth IRA). Applies to
 203, amending Sec. 72(t)    distributions made after 1997 and
                             for expenses paid for academic
                             periods beginning after 1997.

Employer-Provided            For undergraduate courses beginning
 Educational Assistance      after 1996 and before June 1, 2000.
 Exclusion
TRA '97 Section 221,
 amending Sec. 127(d)

Qualified State Tuition      Distributions or educational
 Program                     benefits in excess of contritions
TRA '97 Section 211(b),      made on behalf of the
 amending Sec. 529(c) and    beneficiary are included in the
 (e)                         beneficiary's income. Excess
                             contributions refunded to the
                             contributor are included in the
                             contributor's income. Any Federal
                             gift tax consequences are determined
                             when a distribution is made from an
                             account in the program. No interest
                             in a qualified state tuition program
                             is included in anyone's estate for
                             estate tax purposes, except amounts
                             distributed on account of the
                             beneficiary's death are included in
                             the beneficiary's estate.
                             Contributions to this program or
                             Education IRAs are completed gifts
                             of a present interest from the
                             contributor to the beneficiary at
                             the time of contribution. Annual
                             contributions are generally eligible
                             for gift tax exclusions and
                             excludable from generation-skipping
                             transfer tax.

RELATED ARTICLE: IRA Options and Benefits

IRA                    Roth           Deductible     Nondeductible
benefit                IRA            IRA            IRA

Deductible             No             Yes (if meet   No
 contributions                        AGI limits)

Earnings grow          Tax-free       Tax-deferred   Tax-deferred
 tax-deferred/
 tax-free

Contributions taxed    No             Yes            No
 on withdrawal

Earnings on            No             Yes            Yes
 contributions
 taxed on withdrawal

10% penalty on         Maybe          Maybe          Maybe
 premature
 withdrawals

Maximum annual         Lesser of      Lesser of      Lesser of
 contributions         $2,00          $2,000         $2,000
 per person            or 100% of     or 100% of     or 100% of
                       compensation   compensation   compensation

Subject to minimum     No             Yes            Yes
 withdrawal
 requirements
 after age 70%

Contributions          Yes            No             No
 allowed
 after age 70 1/2

Editor's note: Mr. Bukofsky is the former chair of the AICPA Tax Division's Individual Taxation Committee. Ms. Sherr is the Committee's Technical Manager. Ms. Sherr's views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through specific committee procedures, due process and deliberation.

For more information about this article, contact Mr. Bukofsky at [phone] or [e-mail], or Ms. Sherr at [phone] or [e-mail].