Tax Savings for Education Expenses

Tax Tips Can Save You $$
by Les Bahr
Miller, Bahr & Wills

So, you thought there were no tax benefits for education expenses due to your high income? Well, not necessarily. The Taxpayer Relief Act of 1997 provided numerous higher education related tax-saving opportunities. By now, we hope everyone with kids in college or approaching college age is familiar with the Hope Scholarship and the Lifetime Learning tax credits. Most of you are also aware that these tax benefits are phased out in part or completely to high-income taxpayers. Before explaining how to maximize your tax-planning opportunities in regards to higher education, a brief summary of how each program works would be helpful. 

The Hope Scholarship credit can provide for a dollar-for-dollar reduction in your income tax bill up to a maximum of $1,500 per student per year, based on 100% of the first $1,000 of qualifying expenses and 50% of the next $1,000 of qualifying expenses. Qualifying expenses are defined as tuition and academic fees paid to a post-secondary educational institution offering credit towards a degree. The student must be enrolled on at least a ""half-time"" basis. This credit is available only for the first two years of the student's post-secondary education. 

The Lifetime Learning credit is equal to 20% of the first $5,000 of qualifying expenses paid by the taxpayer during the year. Unlike the Hope credit, the Lifetime Learning credit is available every year for undergraduate or graduate degree programs. Also, the credit can be claimed even if the student attends the institution on a part-time basis. Unfortunately, the availability of both the Hope credit and the Lifetime Learning credit begin to phase-out when modified adjusted gross income reaches $40,000 to $50,000 for single taxpayers and $80,000 to $100,000 for married taxpayers filing jointly. 

If your modified adjusted gross income exceeds the upper limit of the phase-out range, the credits are not available. OR ARE THEY? Recent proposed regulations suggest a way to circumvent these income limitations. If you (the high-income taxpayer/parent) are eligible to claim your child as a dependent but are willing to forego claiming the comparatively paltry dependency exemption of $2,800, your child can claim the appropriate education credit, even if the tuition and expenses were paid by you, the parent. What does this mean? 

Consider the following example. You are married filing a joint return. You have modified adjusted gross income in excess of $100,000. You qualify to claim the dependency exemption for your 18 year old freshman at Princeton University, where first year tuition is $30,000. If you claim your child as a dependent, the $2,800 dependency exemption might save you $900 in federal income tax, provided your income is not so high as to eliminate the dependency exemption itself. (For tax year 2000, this happens when adjusted gross income for joint taxpayers reaches about $193,000.) Conversely, if you forego claiming your child as a dependent, he or she can get a tax credit of up to $1,500. What's the catch? In order to receive the maximum credit of $1,500, your child must have taxable income of at least $10,000. While this situation could make it difficult for many parents to achieve the maximum tax benefit, those parents who are self-employed or shareholders in a closely-held entity have the unique opportunity to hire their children to work in their business and earn enough to maximize the use of the aforementioned tax credits. 

Tax planning for post-secondary education expenses is complicated. Whether your children are in college, approaching college age or still in diapers, there are many opportunities to reduce the effective cost of a post-secondary education for your children. These opportunities exist even if you do not expect to qualify for any financial or merit aid. Planning for these opportunities must consider a wide array of individual circumstances, income limitations and phase-outs and the interaction of the various programs with each other. One thing is certain - the sooner you investigate the possibilities and plan, the greater the ultimate benefit. 

OF COURSE BEFORE YOU MAKE ANY DECISIONS IT IS VERY IMPORTANT THAT YOU FIRST DISCUSS YOUR SITUATION WITH YOUR FINANCIAL TAX ADVISOR. TAX REGULATIONS ARE SUBJECT TO CHANGE AT ANY TIME AND WILL NOT BE INCORPORATED INTO THE ABOVE INFORMATION.
 

This article was contributed by Les Bahr. Les is a Certified Public Accountant with the firm of Miller, Bahr & Wills in Allentown, PA (610-366-1400). Click on the following website name to visit their website: www.mbwcpa.com.

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US Boomers thanks Les Bahr for this Tax Tip.

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