Education Relief.

Highlights from the 2001 Tax Act

Following are highlights of the educational incentives in the 2001 Tax Act, which will not apply to tax years beginning after 2010.

EDUCATION IRAs 

Annual Contribution Limit: For tax years beginning after 2001, the annual contribution limit to education IRAs (Coverdall Education Savings Accounts) for a particular beneficiary will increase from $500 to $2,000.

Qualified Education Expenses: The definition of qualified education expenses that may be paid tax-free from an education IRA is expanded to include qualified elementary and secondary school expenses which are:

* Tuition, fees, academic tutoring, special need services, books, supplies and other equipment incurred in connection with the beneficiary's enrollment or attendance at a public, private or religious school;

* Room and board, uniforms, transportation and supplementary items or services (including extended day programs) required or provided by such a school in connection with the beneficiary's enrollment or attendance; and

* The purchase of any computer technology or equipment or Internet access and related services, if such technology, equipment or services are to be used by beneficiaries and their families during any of the years the beneficiary is in school. Computer software primarily involving sports, games or hobbies is not considered a qualified expense unless the software is predominantly educational.

Phase-out of Contribution Limit: The phase-out range for married taxpayers filing jointly will be $190,000 to $220,000 of modified AGI (twice the range for single taxpayers).

Contributions by Entities: Corporations and other entities, including tax-exempt organizations, can contribute to education IRAs, regardless of their income during the contribution year.

Contribution Deadline: An individual will be deemed to have made an education IRA contribution on the last day of the preceding tax year if the contribution is made on account of that year and made not later than the due date, excluding extensions, for filing the individual's federal income tax return for that year.

Coordination with Education Credits: A taxpayer can claim a HOPE or Lifetime Learning credit for a tax year and exclude from gross income distributions (both the contribution and earnings portions) from an education IRA on behalf of the same student, as long as the distribution is not used for the same educational expenses for which these credits were claimed.

Coordination with Qualified Tuition Programs: The new law repeals the excise tax on contributions to an education IRA during any tax year in which contributions are made to a qualified state tuition program for the same beneficiary.

If distributions from education IRAs and qualified tuition programs exceed the beneficiary's annual qualified higher education expenses, after reduction by amounts used in claiming the HOPE or Lifetime Learning credit, the beneficiary must allocate these expenses between those distributions to determine the amount includible in income.

Education Assistance Exclusion

Under the old law, an employee can exclude up to $5,250 annually of employer-provided educational assistance. There was no exclusion for graduate courses beginning after June 30, 1996. The exclusion for undergraduate courses expires for courses beginning after 2001.

Under the new law, for courses beginning after 2001, this exclusion will apply to graduate education and will be permanent (for both undergraduate and graduate education).

Deduction for Qualified Higher Education Expenses

The new law permits taxpayers a non-itemized deduction for qualified higher education expenses, as defined for the HOPE Credit. (See chart on Page 31.) This deduction is available only for payments made in tax years beginning after 2001 and before 2006.

Taxpayers cannot claim this deduction and an education credit in the same year for the same student.

Taxpayers also cannot claim this deduction for amounts used to determine the amount excludable due to a distribution (i.e., the earnings and contribution portion) from an education IRA or the amount of excludable education savings bonds interest.

Additionally, taxpayers cannot claim this deduction for the amount of a distribution from a qualified tuition plan that is excludable from income. However, taxpayers may claim this deduction for the amount of a qualified tuition plan distribution that is not attributable to earnings.

Student Loan Interest Deduction 

Under the old law, individuals may claim a non-itemized deduction, up to $2,500, for interest paid on qualified education loans during the first 60 months in which interest payments are required (generally excluding voluntary payments). This deduction is phased out based upon the new modified AGI ranges shown on Page 31.

The new law also repeals the 60-month limit during which this interest is deductible and the restriction that voluntary interest payments are not deductible. It applies to interest paid on qualified education loans after 2001.

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation,