If you’re a parent, you’ve probably been worrying about how you’re going to pay for college tuition from the date of conception. And you’re not alone—college tuition, even for state schools, has skyrocketed over the last few years. Even if your college-aged child is able to get a job to help with costs, you’ll definitely see a huge dent in that savings account you started when little Johnnie or Jane was born.
Luckily, there are some valuable tax breaks that we want to make sure you’re aware of. From savings accounts to reimbursements, there are several avenues that you and your accountant should be taking advantage of immediately:
The Tax Deduction:
You can deduct up to $4,000 of college tuition and fees paid for you, your spouse or any other person who was claimed as a dependent on your tax return. Because this is an “above-the-line” deduction, you don’t have to itemize it in order to take advantage of this deduction. Please note that $4,000 is the maximum deduction each year, whether you have one or 10 kids in college at one time.
Be aware that there are some limitations to this deduction, especially in regards to your modified adjusted gross income, so please ask your tax preparer or call us for the details.
Coverdell Education Savings Accounts (CESAs):
These savings accounts allow a parent, or grandparent, to contribute up to $2,000 a year until the “account beneficiary” (i.e. the youngster) turns 18. You can create a CESA for each child, which makes this an efficient savings vehicle for a college tuition fund.
Like Roth IRAs, contributions to the CESA are nondeductible, but the earnings build up tax free, plus you can withdraw the money tax free to pay for the beneficiary’s college expenses. If, for some unknown reason, the funds are not used up for college expenses or your child decides to run off and join the circus instead of attend school, any unused funds can be rolled over to another family member’s CESA.
And the funds don’t have to be used just for university—they can be used for elementary and secondary schools too! There are other benefits to these accounts too, and we’ll be happy to explain them to you.
Tax-Free Employer Benefits:
Have you been wanting to earn a Master’s degree in your field? Or take some classes to improve your productivity at work? Your employer may agree to reimburse you for your course tuition, and if so, up to $5,250 of that income is tax-free. But this can only be applied to you, not your spouse or children.
Section 529 Plans:
If your high income has phased you out of one of the tax breaks above, this one, also called a State-Sponsored College Savings Plan, is for you. Most of these allow lump-sum contributions of over $250,000, and for gift-tax purposes, you can spread that out over five years. Withdrawals from these accounts applied to the account beneficiary’s qualified college tuition are tax-free, of course, and typically offer several investment options, including equity mutual funds.
Student Loan Interest:
The rules for deduction of student loan interest have relaxed recently, allowing for more people to take advantage. If you qualify, you can deduct up to $2,500 of annual college loan interest charges. Unfortunately, this one has phase out ranges if your modified AGI is too high. We can let you know if you qualify, so please call.
American Opportunity and Lifetime Learning Credits:
The American Opportunity credit can be a tricky one, as it can only be claimed for any one student and for only four tax years. After the student has logged more than four years’ worth of academic hours, it becomes unavailable. For 2012, the American Opportunity credit amounts to 100% of the first $2,000 of a college student’s annual tuition and fees (excluding room and board costs) plus 25% of the next $2,000. Therefore the maximum American Opportunity credit is $2,000 per qualifying student.
The Lifetime Learning credit is less restrictive, as it’s mainly intended to offset college costs after the American Opportunity credit is no longer applicable, i.e. after the first four years. The credit equals 20% tuition and fees up to $10,000, for a maximum annual credit of $2,000, and is available for an unlimited number of years and with no requirement for course load, type of degree or even achieving a degree. There are some AGI phase outs for both of these credit types, so we strongly recommend discussing these with your tax preparer or call us with your questions.
If anything in this overview is confusing to you, or you’d like to know how these credits can help you, please give us a call. We’ll be happy to answer all of your questions, and even review your past returns to see if we can save you more money. We can also refer you to our colleagues at an award-winning Orange County financial planning firm to ensure that you are making the most of your tax-free savings opportunities. (714) 637-4552