Printer Friendly
The Free Library
22,719,120 articles and books

Tax planning for college education expenses.

Tax Planning Tax planning

Devising strategies throughout the year in order to minimize tax liability, for example, by choosing a tax filing status that is most beneficial to the taxpayer.
 for College Education Expenses

One major aspect of financial planning Financial planning

Evaluating the investing and financing options available to a firm. Planning includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in the form of a financial plan, and then comparing future performance against
 is to set aside funds for children's education expenses. As the costs of providing a college education continue to escalate es·ca·late  
v. es·ca·lat·ed, es·ca·lat·ing, es·ca·lates
To increase, enlarge, or intensify: escalated the hostilities in the Persian Gulf.

, it has become even more important to carefully plan for these future expenses.

Many of the provisions of the Technical and Miscellaneous Revenue Act of 1988 were designed to close loopholes left by the Tax Reform Act of 1986. However, one significant provision has important implications for parents who wish to plan for their children's college education. The Technical and Miscellaneous Revenue Act of 1988 states that interest income from United States savings bonds United States savings bond

See savings bond.
 may now be excluded from gross income if the proceeds from redemption of the bonds are used to pay higher education higher education

Study beyond the level of secondary education. Institutions of higher education include not only colleges and universities but also professional schools in such fields as law, theology, medicine, business, music, and art.
 tuition expenses.

In the past, it has been suggested that parents purchase U.S. savings bonds Savings bond

A government bond issued in face value denominations from $50 to $10,000, with local and state tax-free interest and semiannually adjusted interest rates.

savings bond

A nonmarketable security issued by the U.S.
 in a child's name and allow the interest to accrue until the bonds are redeemed. This method was beneficial because the child was taxed on the interest income at a lower bracket than the parents. The Tax Reform Act of 1986 has made this alternative unattractive since the unearned income Unearned Income

Any income that comes from investments and other sources unrelated to employment services.

Examples of unearned income include interest from a savings account, bond interest, tips, alimony, and dividends from stock.
 over $1,000 of a child under the age of 14 is now taxed at the parent's bracket. The new provision enacted in the Technical and Miscellaneous Revenue Act contains a major benefit to parents who wish to set aside funds for future college education costs.

A number of stipulations are attached to the new provision. The redeemed bonds must have been issued after December 31, 1989 and the individual purchasing the bonds must be at least 24 years old before the date of issuance. Also, the provision does not apply to bonds acquired by gift. The proceeds must be used to pay qualified educational expenses for enrollment or attendance at an institution of higher learning higher learning
Education or academic accomplishment at the college or university level.
. The proceeds must be spent on qualified higher educational expenses in the same tax year that the bonds are redeemed. The payment may be for the benefit of the taxpayer, the taxpayer's spouse or for any qualified dependent of the taxpayer.

A limitation applies if the proceeds from the redemption of the bonds exceed the taxpayer's higher education expenses for the year. In this situation, the excludible amount of interest is based upon a fraction which must be applied to the total interest income. The numerator numerator

the upper part of a fraction.

numerator relationship
see additive genetic relationship.

numerator Epidemiology The upper part of a fraction
 in the fraction is the amount of qualified education expenses paid for the year. The denominator denominator

the bottom line of a fraction; the base population on which population rates such as birth and death rates are calculated.

 is the total proceeds from the redemption of the savings bonds.

Example 1: Assume that a couple filing jointly pays $3,000 of qualified higher education expenses Qualified Higher Education Expense

Expenses such as tuition and tuition related expenses that an individual, spouse, or child must pay to an eligible post-secondary institution.
 for a dependent child. Also assume that the couple redeems a total of $4,500 in U.S. savings bonds during the year. Assume that the $4,500 includes $3,000 of principal and $1,500 of interest. The amount of interest which may be excluded would be computed according to according to
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

 the following formula:

Excludible Interest = Total Interest income X Qualified Educational Expenses/Total Redemption Proceeds.

The amount of excludible interest in this example would be $1,000 ($1,500 X $3,000/$4,500).

Modified AGI (Artificial General Intelligence) A machine intelligence that resembles that of a human being. Considered impossible by many, most artificial intelligence (AI) research, projects and products deal with specific applications such as industrial robots, playing chess,  Limitation

Another limitation in the provision relates to the taxpayer's modified adjusted gross income. If modified AGI exceeds $40,000 (or $60,000 on a joint return), a fairly complicated phase-out ratio must be used to compute the exclusion.

Modified adjusted gross income is defined as adjusted gross income including:

1. The taxable portion of Social

Security benefits and railroad

retirement benefits, if any, 2. The effect of the limitation

of passive activity losses and

credits, and 3. Adjustments for contributions

made to IRAs and other

qualified retirement plans, and


a. Income earned abroad, b. Income derived from sources

within certain specified

possessions of the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. ,

and c. Income derived from sources

within Puerto Rico Puerto Rico (pwār`tō rē`kō), island (2005 est. pop. 3,917,000), 3,508 sq mi (9,086 sq km), West Indies, c.1,000 mi (1,610 km) SE of Miami, Fla. .

The procedure used to apply the modified adjusted gross income limitations is as follows:

1. The amount of the total

interest which would

ordinarily be excludible is first

determined. For example, if

the total redemption proceeds

exceeds the higher education

expenses, the fraction used

above would be applied first

to determine the amount of

interest ordinarily excludible. 2. The interest ordinarily

excludible is then reduced by a

phase-out computation which

is based on modified adjusted

gross income. The fraction

which is used to multiply by

the excludible interest has as

a numerator the difference

between the taxpayer's

modified AGI and $40,000

($60,000 if filing jointly).

The fraction's denominator is

$15,000 for a single taxpayer

and $30,000 if filing jointly.

The fraction obtained in this

manner is then multiplied by

the ordinarily excludible

interest, and the result is

subtracted from the

ordinarily excludible amount.

The following examples illustrate the operation of the above rules.

Example 2: Assume a taxpayer is single and has a modified adjusted gross income of $50,000. Also assume that he received $2,000 from the redemption of U.S. savings bonds ($1,400 principal and $600 interest). Further assume that the taxpayer paid $2,400 in qualified higher education expenses. In this illustration, the proceeds of the bond redemption do not exceed the total expenses for higher education. Therefore, the limitation discussed in Example 1 does not apply. Ordinarily, the full $600 in interest received from the bonds would be excluded. However, the modified adjusted gross income limitation would require the $600 to be reduced by two-thirds. The manner of obtaining the reduction fraction is shown as follows: {(Modified AGI - $40,000)/$15,000} = {($50,000 - $40,000)/$15,000} = 2/3.

In this example, the taxpayer would only be able to exclude $200 of the interest ($600 - 2/3 of $600) because his modified adjusted income was above $40,000.

Example 3: Assume a taxpayer is married and has a modi fixed adjusted gross income of $75,000. Also assume that the couple received $10,000 from the redemption of U.S. savings bonds ($7,500 principal and $2,500 interest). Further assume that the taxpayer paid $2,000 in qualified higher educational expenses. In this example, two limitations will apply. First, since the bond redemption proceeds exceed the educational expenses, the limitation illustrated in Example 1 must be applied. This computation would be as follows: Excludible Interest = $2,500 Total Interest X $2,000 Qualified Educational Expenses/$10,000 Proceeds. Excludible Interest = $500.

This amount of interest which would ordinarily be excludible would have to be further reduced because the modified adjusted gross income exceeds $60,000. In this example, the $500 would have to be reduced by one-half. The computation of the fraction is as follows: Modified AGI - $60,000/$30,000 = $75,000 - $60,000/$30,000 = 1/2.

As can be observed from the above examples, when a single taxpayer's modified AGI reaches $55,000, no interest exclusion is available. Also, when the modified AGI of a married couple filing jointly reaches $90,000, the interest exclusion is completely phased out.

A few other special rules are applicable with the new provision. The amount of qualified higher education expenses paid must be reduced by amounts received for certain scholarships and veteran's benefits. Also, no exclusion is allowed for married individuals filing separate returns.


Prudent taxpayers should always be concerned with ways to minimize the tax liability. There are now very few provisions in the Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq.  that permit income to be permanently excluded from taxation. Most provisions that favor the taxpayer simply defer the recognition of taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . Furthermore, with the curtailment Curtailment

The act of contracting or reducing operations of a company in the hope of bringing it financial or operational stability. This management technique is often used when a company has grown too fast and is unable to effectively manage its operations.
 of the tax benefit of shifting income to children under the age of 14, the introduction of this provision regarding the exemption of interest on qualified U.S. savings bonds can be very significant for the taxpayer. Taxpayers can obtain maximum benefit from this provision by carefully planning investments in qualified U.S. savings bonds in light of their expectations of future higher education costs. As a result, the cost of higher education, which is constantly escalating, can be significantly subsidized sub·si·dize  
tr.v. sub·si·dized, sub·si·diz·ing, sub·si·diz·es
1. To assist or support with a subsidy.

2. To secure the assistance of by granting a subsidy.
 by the federal government through the use of tax-free interest income.

John Leavins, PhD, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , is associate professor of accounting at the University of Houston-Downtown. Marvin Williams Marvin Gaye Williams, Jr. (born June 19, 1986 in Bremerton, Washington) is an American professional basketball player. He played college basketball under coach Roy Williams at the University of North Carolina. , JD, CPA, is assistant professor of accounting at the University of Houston-Downtown.
COPYRIGHT 1990 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

 Reader Opinion




Article Details
Printer friendly Cite/link Email Feedback
Author:Leavins, John; Williams, Marvin
Publication:The National Public Accountant
Article Type:column
Date:Sep 1, 1990
Previous Article:What are 'grassroots' anyway?
Next Article:Accounting for common interest realty associations.

Related Articles
The costs of higher education.
Federal tax advantages for qualified state tuition programs.
Making college more affordable: the education provisions of the Taxpayer Relief Act of 1997 can help.
College savings vehicles.
Tax incentives for a child's education.
Smart education tax moves: the 2001 act expanded breaks for students and their parents.
Saving for college with 529 plans: what you need to know. (Life Planning).

Terms of use | Copyright © 2014 Farlex, Inc. | Feedback | For webmasters