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Some in Congress have proposed “free” (i.e., government-paid) tuition for community college attendance. Even if that proposal were to become law, it still leaves parents and their children-students responsible for paying for college and university attendance if the student wants a bachelor or higher degree. Over the years, Congress has provided a variety of tax incentives to help defray the cost of education. Some tax-related education benefits are currently available while others will be beneficial only with long-range planning, and the sooner these plans are implemented, the better.
Education Savings Plans – If your children are below college age, there are tax-advantaged plans that allow you to save for the costs of their higher education. While no Federal tax deduction is allowed for contributions to the plans, they do provide tax-free accumulation of earnings. It, therefore, makes sense that the earlier they are established, the more benefit you’ll get from them. Additionally, state tax deductions of up to $20,000 per year are allowed for certain plans.
In recent years Congress has expanded the definition of eligible expenses 529 Plans can cover to include the following:
Coverdell Education Savings Account—These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools. A total of $2,000 per year can be contributed (but is not deductible) for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income of the contributor is between $190,000 and $220,000 for married taxpayers filing jointly, and between $95,000 and $110,000 for all others.
Education Tax Credits—If you currently have a child or children attending college, there are two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), that may benefit you. Both are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce your tax liability dollar for dollar until the tax reaches zero.
Qualifying expenses for these credits are generally limited to tuition. However, if required for the enrollment or attendance of the student, activity fees and fees for course-related books, supplies, and equipment qualify. For those accessing the Lifetime Learning Credit, course materials and supplies are eligible only if purchased directly from the educational institution.
Qualified tuition and related expenses paid by a student are treated as if paid by the taxpayer if the student is a claimed dependent of the taxpayer. So if a third party (most typically a grandparent, but it could be anyone besides you or the dependent) makes a payment directly to an eligible educational institution for the student’s qualified tuition and related expenses, the student would be treated as having received the payment from the third party and would qualify as having paid the tuition and related expenses personally. If the student is your dependent, you could be eligible to claim the credit.
Education Loan Interest—You can deduct qualified education loan interest of up to $2,500 per year in computing AGI. This is not limited to government student loans and could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2022, the student loan interest deduction phases out for married taxpayers with an AGI between $145,000 and $175,000 and for unmarried taxpayers between $70,000 and $85,000. These amounts are subject to annual inflation adjustment. This deduction is not allowed for taxpayers who file married separate returns.
While it is possible that Congress may add more tax-related benefits for assisting parents and students to pay for higher education costs, you shouldn’t depend on their actions (or inactions). We recommend starting the planning process as soon as possible, and making sure not to overlook the credits and deductions available for the current students in your family. If you would like assistance in planning for your children’s future education or would like more information about the education benefits available now, please call us at (630) 953-4900.