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Tax benefits for higher education: a planning toolbox for CPAs.

With annual college expenses running as high as $50,0CX), CPAs should be aware of the opportunities the IRS offers taxpayers for 2011. Although, dollar for dollar, credits are usually the preferred choice, CPAs should help taxpayers review the requirements and limitations of both credits and deductions and choose the method that will best minimize their tax liabilities.

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Tax Benefits for Saving for Higher Education

IRC section 529 plans. Under IRC section 529, individuals may contribute to a qualified tuition program (QTP) on behalf of any beneficiary. Contributions made to a QTP are not deductible on the federal tax return, but the investment grows tax-free and the distributions to pay for the beneficiaries' qualified education expenses are tax-free to the beneficiary, as long as the distribution is not more than the beneficiary's qualified higher education expenses. This tax-free treatment was made permanent with the Pension Protection Act of 2006 signed by President Georg W. Bush,

Tuition and other expenses required to be paid to the educational institution for enrollment or a course----such as required student activity fees, special needs services, books, supplies, and equipment---are considered to be qualified education expenses. For 2009 and 2010, qualified higher education expenses also included expenses for computer technology and equipment or Internet access and related services. As of January 1, 2011, however, 529 plan with-drawals are not tax-free when paying for these technology costs. Expenses for room and board incurred by students who are enrolled at least half-time are considered a qualified education expense. But the amount of the room and board cannot be greater than the allowance for room and board, as determined by the educational institution, or the actual amount charged, if the student is residing in housing owned or operated by the educational institution. Insurance, medical, and other personal expenses are not considered qualified education expenses. Education credits or tuition deductions can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used in the tax calculations for the credits or deductions. If a beneficiary receives taxable distributions from both a QTP and a Coverdell Education Savings Account (ESA) in the same year, as discussed below, the postsecondary expenses must be allocated between the distributions.

Where is the income claimed? If any of the 529 plan distribution is taxable due to its being greater than qualified education expenses, the excess would be included as "other income" on Form 1040.

Who can claim the income? If any of the 529 plan distribution is taxable, the taxable portion would be reported on the beneficiary's tax return.

What expenses are eligible? Undergraduate and graduate studies qualify.

Exclusion of interest earned on education savings bonds. Under IRC section 135, a taxpayer may be able to cash qualified U.S. savings bonds and not include all or some of the interest earned on the bonds if the proceeds are used to pay qualified education expenses for the taxpayer and the taxpayer's spouse or dependent, and the taxpayer's modified adjusted gross income (AGI) is less than $85,100 (if single or head of household) or $135,100 (if married filing jointly or a qualifying widow). Qualified education expenses are tuition and fees paid to attend an eligible educational institution, including payments to a qualified tuition plan (529 plan) or to a Coverdell ESA. Education credits or tuition deductions can be claimed in the same year the beneficiary uses the qualified U.S. savings bonds to pay tuition expenses, as long as the same expenses are not used in the tax calculations for the credits or deductions.

Where is the exclusion taken? Form 8815, Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989, is used to calculate the education savings bond interest exclusion.

Who can claim the exclusion? Any taxpayer paying qualified higher education expenses during the current tax year for himself, his spouse, or dependent can claim the exclusion. However, the taxpayer's filing status cannot be married filing separately.

What expenses are eligible? Undergraduate and graduate studies are eligible.

Coverdell ESA. Similar to an IRC section 529 plan, contributions made to a Coverdell ESA (IRC section 530) are not deductible on the federal tax return, but the investment grows lax-free and the distributions to pay for the beneficiaries' qualified education expenses are tax-free to the beneficiary, as long as the distribution is not more than the qualified higher education expenses. Postsecondary tuition and other related expenses such as student activity fees required for college enrollment, qualified room and board (see above), books, special needs services, supplies, and equipment are considered qualified education expenses. For an eligible elementary or secondary .school, tuition and other related expenses such as books, special needs services, supplies, academic tutoring, and equipment are qualified expenses. Room and board, uniforms, transportation costs, and supplementary expenses required by the elementary or secondary school also qualify. Compared to a 529 plan, the Coverdell ESA has lower maximum contribution limits and more investment choices. It also has an age limit on distributions, can be used for qualified elementary and secondary school expenses, and contributions may be restricted based on the income level of the donor. Education credits or tuition deductions can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used in the tax calculations for the credits or deductions. If a beneficiary receives taxable distributions from both a QTP and a Coverdell ESA in die same year, the postsecondary expenses must be allocated between the distributions.

Where is the income claimed? If any of the ESA plan distribution is taxable (due to its being greater than qualified education expenses), this excess amount would be included as "other income" on Form 1040.

Who can claim the income? If any of the ESA plan distribution is taxable, this portion would be reported on the beneficiary's tax return as "other income" on Form 1040.

What expenses are eligible? Undergraduate and graduate studies are eligible, as are grades kindergarten through 12.

Status. The Coverdell ESA was scheduled to expire at the end of 2010. In December 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, signed into law by President Obama, extended this benefit for two more years.

Uniform Transfers to Minors Act (UTTMA). Created in 1986 by the U.S. Uniform Law Commission, the UTTMA allows taxpayers to create bank or brokerage accounts in trust for a minor without going to the expense of creating a formal trust. A custodian manages the account until the minor reaches 18 or 21, depending upon the state, but the income earned on the account is credited to the minor's Social Security number Proceeds from the account can be--but are not required to be--used for education expenses. There are no special tax considerations related to the use of monies in a UTTMA account to pay for education expenses.

Tax Benefits for Current Expenses

American Opportunity Tax Credit The American Recovery and Reinvestment Act (ARRA) was enacted in 2009 to stimulate jobs and promote investment and spending, and section 1004 of the act created a partially refundable American Opportunity Tax Credit under IRC section 25A, aimed at helping parents and students pay part of the cost of the first four years of college. Applicable for tax years 2009 and 2010, the amount deductible is 100% of qualified tuition, fees, and course materials paid by the taxpayer during the taxable year, not to exceed $2,000, plus 25% of die next $2,000 in qualified tuition, fees, and course materials. The total credit cannot exceed $2,500 per year and per student, but if the credit is more than the calculated tax liability, the taxpayer may be entitled to a refund of 40% of the amount of the credit, up to $1,000. The credit cannot be claimed if the taxpayer's modified AGI is $90,000 or more ($180,000 for married couples filing jointly). In addition, the American Opportunity Tax Credit can only be claimed for the same student for a total of four years.

ARRA section 1004 modified the Hope Scholarship Credit for 2009 and 2010 by allowing an increase in the amount that can be deducted from $1,800 to $2,500, revising the definition of qualified education expenses to include course materials, and expanding eligible expenses from the first two years of college to the first four years. Now. in addition to tuition and other related expenses such as student activity fees required for college enrollment, books, .supplies, and equipment purchased for a course may be deductible even if they were not purchased from the educational institution. Costs such as room and board, insurance, medical, and other personal expenses are not considered qualified education expenses.

Where is the credit claimed? The credit is claimed using Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits), attached to Form 1040 or 1040A.

Who can claim the credit? The credit is applicable to qualified education expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent, as long as an exemption is claimed for the dependent by the taxpayer and is available on a per-student basis. However, the taxpayer's filing status cannot be married filing separately. The .student must be pursuing a degree or a recognized education credential and must be enrolled at least half-time for at least one academic period during the year.

What expenses are eligible? The first four years of undergraduate studies per eligible student qualify for the credit.

Status. The American Opportunity Tax Credit was scheduled to expire at the end of 2010, but was extended for two years by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.

Lifetime Learning Credit While the American Opportunity Tax Credit allows a credit for qualified education expenses for the first four years of college, the Lifetime Learning Credit (under IRC section 25A) allows a credit for undergraduate, graduate, and job skills courses. The nonrefundable Lifetime Learning Credit is equal to 20% of the taxpayer's out-of-pocket expenses, up to a maximum of $ 10,000 in qualified expenses; therefore, the maximum Lifetime Learning Credit a taxpayer may claim per family each year is $2,000 ($10,000 x .20). The Lifetime Learning Credit cannot be claimed, however, if the taxpayer's modified AGI is $60,000 or more ($120,000 for married couples filing jointly). While the American Opportunity Tax Credit can be claimed for the same student for no more than four years, (he Lifetime Learning Credit is available for an unlimited number of years. Tuition and other related expenses (such as student activity fees) required: is a condition of enrollment, as well as books, supplies, and equipment required to be paid to the educational institution for a course are considered qualified education expenses. Costs such as room and board, insurance, medical, and other personal expenses are not considered qualified education expenses.

Where is the credit claimed? The credit is claimed using Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits), attached to Form 1040 or 1040A.

Who can claim the credit? The credit is applicable to qualified education expenses paid on behalf of the taxpayer, taxpayer's spouse, or a dependent, as long as an exemption is claimed for the dependent by the taxpayer. However, the taxpayer's filing status cannot be married filing separately. The student does not need to be pursuing a degree or a recognized education credential, and the credit is available for one or more courses.

What expenses are eligible? Undergraduate and graduate studies quality for the credit, as well as courses aimed at acquiring or improving job skills.

If a taxpayer pays qualified education expenses for more than one student in the same year, the taxpayer can claim the American Opportunity Tax Credit for one student and the Lifetime Learning Credit for another student in the same year. A taxpayer cannot, however, claim the American Opportunity Tax Credit, the Lifetime Learning Credit, and a tuition and fees deduction for the same student in a single year.

Qualified education expense above-the-line deduction--tuition and fees deduction. The American Opportunity Tax Credit and the Lifetime Learning Credit reduce the federal income taxes paid dollar for dollar. but the tuition and fees deduction is a deduction from income in order to arrive at AGI. Under the provisions of IRC section 222, if a taxpayer does not take the credits on his tax return, he may be able to deduct up to $4,000 per year (for 2011) of qualified college tuition and expenses related to undergraduate and graduate courses. The tuition and fees deduction is subject to a phase-out for taxpayers with AGI in excess of $80,000 ($160,000 for married couples filing jointly).

Tuition and other related expenses (such as student activity fees) paid as paid of the enrollment, as well as books, supplies, and equipment required to be paid to the educational institution for a course are considered qualified education expenses. Costs such as room and board, insurance, medical, and other personal expenses are not considered qualified education expenses.

Where is the deduction claimed? This adjustment to income is claimed using Form 8917, Tuition and Fees Deduction, attached to Form 1040 or 040A.

Who can claim the deduction? The deduction is applicable to qualified education expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent, as long as an exemption is claimed for the dependent by the taxpayer. However, the taxpayer's filing status cannot be married filing separately. In addition, a taxpayer cannot take an education credit from Form 8863, a business deduction for work-related education expenses (see below), and the tuition and fees deduction from Form 8917 for the same student for the same tax year. Taxpayers should consider all of the available options and choose the one resulting in the lowest overall amount of taxes due.

What expenses are eligible? Undergraduate and graduate studies qualify for this deduction.

Business deduction for work-related education. If a taxpayer itemizes her deductions and is working, she can deduct the costs of qualifying work-related education as a business expense. These are expenses required by an employer or die law to keep a current job, salary, or status or to improve or maintain skills needed for a present position. An education expense is not a qualifying deductible education expense if the education is needed to meet the minimum qualifications of the job or will quality the worker for a new position. Tuition and other related expenses (such as student activity fees) required to be paid for college enrollment, as well as books, supplies, and equipment required to be paid to the educational institution for a course are considered qualified education expenses. The cost of transportation from work to school is also a qualified education expense. The cost of transportation from school to home may be a qualified education expense if the worker is regularity employed and goes to school on a temporary basis (i.e., if the schooling is expected to last one year or less). Costs such as room and board, insurance, medical, and other personal expenses are not considered qualified education expenses. The IRS allows several different education benefits, but the same education expenses cannot be used to claim multiple credits 0r deductions.

Where is the deduction claimed? The deduction is claimed on Schedule A (subject to the 2% of AGI rule), or Schedule C, if a taxpayer is self-employed.

Who can claim the deduction? Any taxpayer who is working and itemizes (or files Schedule C if self-employed) and has qualifying work-related education expenses can claim the deduction.

What expenses are eligible? Classes taken to keep a taxpayer's present salary, status, or job, or taken to maintain or improve skills needed in present work, are eligible.

Education exception to additional tax on early IRA distribution. Normally, if a taxpayer withdraws funds from an IRA before reaching age 59 1/2, he must pay an additional 10% penalty on the early distribution. If a taxpayer decides to withdraw money from an IRA to pay for education expenses, and the taxable part of the distribution is less than or equal to the adjusted qualified education expense, the additional 10% penalty is waived. Tuition and other related expenses (such as student activity fees) required to be paid for college enrollment, as well as books, supplies, special needs services, and equipment required to be paid to the educational institution for a course are considered qualified education expenses. If the student is at least a half-time student, room and board is also considered a qualified expense. The amount of the room and board cannot be greater than the allowance for room and board as determined by the educational institution or the actual amount charged if the student is residing in housing owned or operated by the educational institution.

Where is the benefit claimed? The benefit is claimed on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

Who can claim this benefit? The deduction is applicable to qualified education expenses paid on behalf of the taxpayer, the taxpayer's spouse, and the taxpayer's or spouse's child (or descendant).

What expenses are eligible? Payment is made for qualified education expenses and, in some cases, room and board.

Employer-provided educational assistance. If a taxpayer receives educational assistance benefits for either undergraduate-or graduate-level courses from an employer under an educational assistance program, benefits up to $5,250 do not need to be included on her tax return, under the provisions of IRC section 127. Amounts greater than $5,250 are taxable and should be included in the W-2, Box 1 (Wages, Tips, and Other Compensation). Qualified education expenses include tuition, fees, books, supplies, and equipment. Meals, lodging, transportation, tools, or supplies that can be kept after completing the course, and courses involving sports, games, or hobbies (unless they are business-related or are required to earn a degree) are not eligible under IRC section 127.

What expenses are eligible? Undergraduate and graduate expenses are eligible for this exclusion.

Status. The employer-provided education assistance benefit was scheduled to expire at the end of 2010. but was extended for two years by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,

Tax Benefits Relating to Past Expenses

Student loan interest deduction. If a student, spouse, or dependent is pursuing a degree or a recognized education credential and is enrolled at least half-time for at least one academic period beginning during the current year, the interest paid on any loans associated with that education may be deductible under IRC section 221. The maximum deduction for interest on loans taken to pay tuition, room and board (see above), and other related expenses of attending an eligible educational institution (including graduate school) is $2,500 per year for taxpayers with modified AGI of less than $75,000 ($150,000 for married couples filing jointly).

Where is the deduction claimed? The deduction is claimed on Form 1040 or 1040A as an adjustment to gross income.

Who can claim the deduction? A taxpayer can deduct interest on a loan used to pay qualified education expenses on behalf of the taxpayer, the taxpayer's spouse, or a dependent. However, the taxpayer's filing status cannot be married filing separately.

Status. The student loan interest deduction was scheduled to expire at the end of 2010, but was extended for two years by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Money Available Through Grants

The federal Pell Grant, as described in Title IV of the Higher Education Act of 1965 and sponsored by the U.S. Department of Education, is based on financial need. Recipients are not required to repay the grant. The Federal Supplemental Educational Opportunity Grant (FSEOG) works similarly to the Pell Grant. Generally, grants are tax-free when the proceeds are used to pay qualified education expenses during the period die grant is awarded. (See www.grants.gov for more information on Pell Grants and www. fseog.com for more on FSEOG grants.)

Where to Go from Here?

Many taxpayers struggle to save enough to pay for their children's college tuition. If a child does not qualify for free tuition, taxpayers first need to decide if they can afford higher education on their current income or if they need to finance the amount through an educational loan. The feasibility of other methods of financing a taxpayer's education not discussed in this article (such as a home equity loan) should also be considered. If a taxpayer determines that an outside loan is necessary, federal Stafford loans (www.staffordloan.com) usually have a lower interest rate than comparable private loans, and federal Perkins loans (www2.ed.gov/programs/fpl/index. html) may also be available.

Once taxpayers start making tuition payments, their tax advisor should look at the various credits and deductions allowed to determine which will best minimize any taxes due. Some of the more popular education tax credits and deductions are described above. Taxpayers should also always be aware that a high modified AGI will affect the availability of the education credits and deductions.
EXHIBIT 1

Possible Credits

                           Education        Graduate/
Credit       Refundable?   Costs Allowed    Undergraduate?

American     Partially.    Tuition, fees,   First four
Opportunity  If AOTC is    course-related   years
Tax Credit   less than     books,           undergraduate
             tax           supplies,
             liability,    Equipment
             excess is
             refundable
             up to 40% of
             the eligible
             credit.

Lifetime     No            Tuition, fees,   Undergraduate/
Learning                   course-related   graduate and
Credit                     books,           courses to
                           supplies,        improve job
                           equipment that   skills
                           must be paid to
                           educational
                           institution

             Other           Who Is      Years      Maximum
Credit       Considerations  Eligible?   Available  Credit

American     Must be         Taxpayer,   Four tax   $2,500
Opportunity  enrolled        spouse,     years per  per
Tax Credit   half-time       dependent   eligible   eligible
                             claimed on  student    student
                             tax
                             return

Lifetime     None            Taxpayer,   Unlimited  $2,000
Learning                     spouse,     number of  per
Credit                       dependent   years      return
                             claimed on             (20% of
                             tax                    expenses
                             return                 to
                                                    maximum
                                                    expenses
                                                    of
                                                    $10,000)

EXHIBIT 2

Possible Deduction

Deduction  Education Costs  Graduate/        Other
           Allowed          Undergraduate?   Considerations

Tuition    Tuition and      Undergraduate/   Cannot claim
and Fees   other related    graduate         both deduction
Deduction  expenses (e.g.,                   and education
           student                           credit for same
           activity fees)                    student in same
           paid as part of                   year
           enrollment,
           books,
           supplies, and
           equipment
           expenses

Business   Tuition and      Classes taken    Education
Deduction  other related    to keep current  expense cannot
           expenses (e.g.,  salary, status,  be required to
           student          or job or to     meet minimum
           activity fees)   maintain or      qualifications
           paid as part of  Improve skills   of job or to
           enrollment,      needed in        qualify for a
           books,           current work     new position.
           supplies, and
           equipment
           expenses; in
           some cases,
           transportation
           and travel
           expenses

Deduction  Who Is          Maximum
           Eligible?       Deduction

Tuition    Taxpayer,       $4,000 per
and Fees   spouse,         year
Deduction  dependent
           claimed
           claimed on tax
           return.

Business   Taxpayer who    Not
Deduction  itemizes        applicable
           deductions or
           is
           self-employed

EXHIBIT 3

Tax Benefits for Saving

Deduction  Education Costs  Graduate/        Other
           Allowed          Undergraduate?   Considerations

529        Tuition, fees,   Undergraduate/   Must be
Qualified  course-related   graduate         enrolled at
Tuition    books, supplies                   least
Program    equipment, room                   half-time
           and board,
           transportation

Interest   Tuition, fees,   Undergraduate/   Applies to
Exclusion  payments to      graduate         qualified
           Coverdell and                     Series EE bonds
           529 plans                         issued after
                                             1989 or Series
                                             I bonds

Coverdell  Tuition, fees,   Undergraduate/   Assets must be
ESA        course-related   graduate/grades  distributed at
           books,           K-12             age 30, unless
           supplies,                         special-needs
           equipment. For                    beneficiary
           K-12, room and
           board,
           transportation

Deduction  Who Is
           Eligible?

529        Income to
Qualified  beneficiary,
Tuition    to extent I
Program    distribution
           exceeds
           qualified
           education
           expenses

Interest   Taxpayer,
Exclusion  spouse,
           dependent
           claimed on
           tax return

Coverdell  Income to
ESA        beneficiary,
           to extent
           distribution
           exceeds
           qualified
           education
           expenses



Patricia Z. Galletta, MBA, CPA, is an assistant professor of accounting al the College of Staten Island, Staten Island, N.Y.
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Title Annotation:personal financial planning
Author:Galletta, Patricia Z.
Publication:The CPA Journal
Date:Oct 1, 2011
Words:3966
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