Friday, November 27, 2009


Earlier this week I discussed the new American Opportunity Credit for qualified post secondary tuition, fees and course material expenses.

The AOC is only one of many items on the “menu” of education tax benefits.

THE AOC replaces the HOPE education credit. The other credit available for educational expenses is the Lifetime Learning Credit, which it non-refundable. While the AOC is limited to the first 4 years of post-secondary education, and cannot be claimed more than 4 tax years, the Lifetime Learning Credit is available for all years of postsecondary education and for courses to acquire or improve job skills and for an unlimited number of years.

The Lifetime Learning Credit is also available for all years of postsecondary education, including graduate school, as well as for education to acquire or improve job skills. The student does not have to be pursuing an undergraduate degree or other recognized education credential and it is available for a single class. The cost of course materials cannot be used in calculating the Lifetime Learning Credit.

The amount of the credit is 10% of up to $20,000 in qualified expenses for a maximum of $2,000. While the AOC is $2,500 maximum is per student, the Lifetime Learning credit $2,000 maximum is per tax return. You can have two dependents in college during the year, and each can claim up to $2,500 of the American Opportunity Credit. But if you have two dependents in graduate school in the same year the maximum Lifetime Learning Credit you can claim for both combined is $2,000.

The phase out range is for “modified” AGIs of between $50,000 and $60,000 for singles and $100,000 and $120,000 for married couples. It is not available to married taxpayers who file separately.

Special rules apply for both credits for a student attending college in a Midwestern disaster area.

Click here for a good IRS-published comparison of the two credits.

You can claim an “above-the-line” deduction (“adjustment to income”) for qualified tuition and fees. This deduction is limited to $2,000 for modified Adjusted Gross Income of up to $65,000 for singles and $130,000 for married couples filing joint and $4,000 for MAGI of up to $80,000 for singles and $160,000 for joint filers. The deduction is not available for married taxpayers who file separately.

The deduction is available for tuition and fees and student-activity fees and course-related books, supplies and equipment if they must be paid as a condition of enrollment or attendance.

Taxpayers can also claim an itemized deduction as an “employee business expense”, or a deduction on Schedule C if self-employed, the cost of education that is (1) expressly required by an employer, by law, or by government regulation, or (2) maintains or improves skills required in your current trade or business. Education is not deductible if it (1) is the minimum requirement for a trade or business, or (2) prepares one for a new trade or business, even if the taxpayer does not intend to enter the new trade or business.

Deductible expenses include –

• tuition, textbooks, registration fees, and supplies,
• round-trip transportation to the education (the only time travel is deductible),
• meals (at 50%) and lodging while away from home,
• lab fees, student cards, insurance and degree costs, and
• writing expenses for term papers and dissertations (i.e. research and typing)

Generally expenses for education that lead to a degree are not deductible, as it is assumed that an undergraduate degree is the “minimum requirement” for a trade or business and a graduate degree prepares one for a new trade or business. See my post on “Is An MBA Deductible”. A graduate degree may also be deductible for teachers.

There are no income or AGI limitations involved with such a deduction, other than the 2% of AGI exclusion for “miscellaneous” itemized deductions.

With a deduction the tax benefit received is determined by your marginal tax rate (i.e. are you in the 10%, 15%, 25%, 28% or 35% tax bracket).

When determining whether to claim a credit, above-the-line deduction, or Schedule A or C deduction for education, as in any situation when you are given options, you should calculate the tax benefit under each each option to determine the one that provides the most overall federal, state and local tax savings. While a credit is generally better than a deduction, this is not always the case. Because of AGI and other considerations I have often come across returns where it was “more better” to claim a deduction than a credit.

For parents of newborns or young children perhaps the best way to save for their college education is with a Qualified Tuition Program (QTP), also known as a “Section 529 Plan”. Contributions to a 529 Plan are not deductible, but the earnings that accrue over the years are tax-free if used for qualified education expenses. For purposes of Section 529 qualified expenses include tuition, required fees, books, supplies, equipment, computer equipment and services (for 2009 and 2010), special needs services, and, for someone who is at least a half-time student, room and board.

There are no statutory limitations to the amount that can be contributed to a Section 529 Plan, other then they cannot be more than the amount necessary to provide for the qualified education expenses of the beneficiary, but there are Gift Tax considerations, and there are no AGI or MAGI income phase-outs. Anyone can contribute to a Section 529 Plan regardless of income.

Here is a great idea – use the cash gifts your newborn receives to open a Section 529 Plan.

For more information on Section 529 Plans click here.

You can also save college using the Coverdell Education Savings Account. Parents and family members can contribute up to a maximum of $2,000 per student beneficiary per year to a Coverdell ESA.

As with a Section 529 Plan, contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed and distributions are tax-free if they are used for a beneficiary’s qualified education expenses at an eligible institution.

What is good about a Coverdell ESA is that distributions can be used for qualified education expenses for Kindergarten through 12th Grade as well as college and graduate school. Qualified expenses include tuition, fees, books, supplies and equipment (not computers), and room and board for students who are enrolled at least half-time.

Of course there is a “modified” AGI phase-out range - $95,000 to $110,000 for singles (including Married Filing Separate) and $190,000 to 220,000 for Married Filing Joint.

The above are only a few of the items on the “education menu”. Click here for an IRS-published overview of the education menu. More detailed information is available in IRS Publication 970 (Tax Benefits for Education).

There are special rules for coordinating the interaction of the various items on the education menu. For more information you should consult your tax professional.


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