Tax-Favored
Ways to Pay for College
Paying for college might be a
little easier now for middle-income families, thanks to a number of changes to
the tax law. Two education tax credits, the Education IRA and a break on student
loan interest, should help make post-secondary education more affordable for
millions of Americans.
The Hope Scholarship Credit and The Lifetime
Learning Credit
The Hope Scholarship credit
provides a federal tax credit for the first $1,000, and up to $500 of the next
$1,000, of qualified tuition and related expenses incurred in the first two
years of post-secondary education. Qualified expenses include tuition and course
fees, but not books, board, meals, transportation, or other fees.
To qualify for the credit, the
student must attend an eligible educational institution at least halftime in
pursuit of a degree. A family is entitled to claim a Hope tax credit for each
student who is enrolled in a qualified higher education program. But good
behavior is a must: the Hope credit is not allowed for students who are
convicted of federal or state felony possession of a controlled substance.
In addition to the Hope
Scholarship credit, a Lifetime Learning credit is available for education
furnished after June 30, 1998. The Lifetime Learning credit covers undergraduate
education and all the years of graduate and professional studies. This credit is
also available — even for part-time study — to adults who want to upgrade
their job skills, acquire new ones, or pursue another course of study. The
credit is calculated at 20 percent of up to $5,000 of qualified tuition and fees
for a maximum credit of $1,000 per year.
The $1,000 covers all of a
family’s students collectively. You don’t get a separate credit for each
student. There is no limit, however, on the number of years a taxpayer may claim
the Lifetime Learning credit. A family can claim the Hope tax credit for some
members of the family and the Lifetime Learning credit for others who qualify in
the same year.
Both the Hope Scholarship and
the Lifetime Learning credits are phased out for joint filers who have between
$80,000 and $100,000 of adjusted gross income (AGI), and for single filers whose
AGI is between $40,000 and $50,000. To take advantage of the Hope and/or
Lifetime Learning credits, you must complete and submit IRS Form 8863 with your
federal tax return.
Education IRAs
If you qualify, you can
contribute up to $500 every year in an Education IRA for each child under age
18. You can then use the funds that accumulate in that account to pay for higher
education. Although contributions are not deductible, the distributions,
including earnings, are tax-free if used to pay for qualified educational
expenses, which include tuition, room, board, books and supplies. The amount you
contribute to Education IRAs does not affect the amount you may contribute to
other IRA plans.
Married couples with adjusted
gross income (AGI) as high as $150,000 qualify to make a full $500 contribution.
If your AGI exceeds $150,000, your allowable contribution is lower and phases
out completely when your AGI reaches $160,000. Singles are eligible for a full
contribution with income as high as $95,000, phasing out completely at $110,000.
Any balance remaining in an Education IRA must be distributed within 30 days
after the beneficiary reaches age 30. The earnings portion of the distribution
must be included in the beneficiary’s gross income and is subject to a 10
percent penalty. Another alternative is to roll over the balance tax-free into a
new Education IRA for another member of the original beneficiary’s family who
is under age 30.
Keep in mind that you cannot
take either the Hope or Lifetime Learning credit in a year you receive a
distribution from an education IRA, unless you elect to waive the income
exclusion. The tax credits may very well be worth more to you than the education
IRA if you don’t start it when the child is very young.
Student Loan Interest Deduction
Taxpayers who have taken loans
to pay college costs for themselves, a spouse, or a dependent may deduct at
least a portion of the interest they pay on those loans. Beginning in 1998, an
above-the-line deduction is available for interest paid on qualified education
loans. The maximum interest deduction is $1,500 in 1999, $2,000 in 2000, and
$2,500 in 2001 and beyond. You can claim this deduction whether or not you
itemize your deductions. Married couples filing jointly with AGIs up to $60,000
qualify, phasing out at $75,000; for single filers, it’s $40,000, phasing out
at $55,000. The deduction is allowed for interest paid during the first 60
months in which interest payments are required.
A college education can translate into additional
income and a better life. If you’re not sure how to make the most of these
education-related tax benefits,
consult with your tax professional.