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The costs of higher education.

One of the biggest problems facing many parents today is trying to figure out how to pay for their children's education. The rising costs of college education may impose significant burdens on many families; finding ways to finance these expenses may require extensive thought and planning.

In 1988, Congress enacted Internal Revenue Code section 135, which excludes from income the interest from series EE U.S. savings bonds if the proceeds from their redemption are used for specific higher education expenses.


Qualified bonds include those issued after 1989 at a discount to taxpayers who are at least 24 years old before the date of issuance.

A qualified bond purchaser may designate anyone as the beneficiary; however, the interest exclusion is not available if the bonds are bought from another taxpayer (other than a spouse) or are put into the name of a child or other dependent. In addition, the interest is not excludable if the bonds are purchased with redemption proceeds rolled over from series E bonds.

Income limits. A taxpayer must meet certain income limits to exclude the interest; as income increases, the accrued interest otherwise excludable is reduced. Prior to the Small Business Job Protection Act of 1996, which requires different inflation calculations, taxpayers filing jointly for 1996 with modified adjusted gross income of $65,250 or less ($43,500 or less for single taxpayers) could exclude the full amount of qualified interest. When the 1996 income level reached $95,250 for taxpayers filing jointly ($58,500 for single taxpayers), the taxpayer was no longer entitled to any interest exclusion.

The exclusion is not available at all to married taxpayers filing separately; excludable interest also is limited by the qualified higher education costs paid in the tax year. Such costs include tuition and fees for enrollment and attendance at an eligible educational institution; room, board, books and supplies are not included. Eligible institutions include most public and nonprofit higher education and postsecondary education institutions (including many vocational schools and junior colleges). Programs that qualify include nursing, two-year degree programs, one-year programs that prepare students for employment and meet certain criteria, technical institutes and vocational programs.


A relatively new vehicle for funding education costs is the tuition guarantee (or prepaid tuition) program. Typically, these programs involve the purchase of a prepayment contract or annuity from a state or education institution; when a designated beneficiary enrolls in college, the contract can be redeemed to pay all (or a portion) of the college costs.

The cost of the arrangement varies with the age of the beneficiary; generally, the younger the child, the smaller the payment. Under most plans, cash refunds are provided under specified circumstances, such as if the beneficiary does not attend college.

Qualified state tuition programs. The Job Protection Act includes IRC section 529, which codifies the tax treatment of qualified state tuition programs and their participants.

A qualified state tuition program, as defined in section 529, is one established by a state (or agency or instrumentality thereof) under which a person may (1) purchase tuition credits or certificates for a designated beneficiary that entitle the beneficiary to a waiver of or payment of qualified higher education expenses or (2) contribute to an account established to meet the designated beneficiary's qualified higher education expenses. Purchases or contributions can be made only in cash. This provision does not apply to private universities.

Tax treatment. Neither the parent (the contributor) nor the child (the beneficiary) is currently taxed on a program's investment earnings. The contributor is taxed only if funds are refunded to him or her and then only to the extent the refunded amount exceeds contributions. The beneficiary is taxed on the program's earnings when they are distributed or when education benefits are provided.

For a detailed discussion of these and other financing techniques, see "Practical Tax Planning for Higher Education Costs," by Jim Swayze and John Zimmerman, in the November 1996 issue of The Tax Adviser.

--Nicholas Fiore, editor The Tax Adviser
COPYRIGHT 1996 American Institute of CPA's
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Copyright 1996, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:From the Tax Adviser
Author:Fiore, Nicholas
Publication:Journal of Accountancy
Date:Nov 1, 1996
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