Randy J. Elder, CPA, P.C.

Borrowing for education? Don’t overlook tax implications

Continuing on my education theme of last week, today I’ll focus specifically on the tax implications when borrowing for education. There are many excellent public and private colleges and universities in Arizona and around the Phoenix area.

Arizona State University

If you, your child or spouse are pursuing higher education from one of these organizations and you find that borrowing to pay for education expenses is the way you need to go, you should know that there are two types of loans that you may be able to claim a tax deduction for interest paid; home equity and education loans. Of course, the conditions of the borrowed money must meet certain requirements to qualify for the tax deduction.

Home Equity Loan

Now that the housing market has somewhat recovered and many have regained equity in their homes, a home equity loan for education expenses is once again a viable option. If you itemize your deductions and have built up sufficient equity in your home, this option might be right for you. Typically, you can take $100,000 of equity debt on your home and still deduct the interest paid on the loan against the regular tax. However, the interest on equity debt is not deductible against the Alternative Minimum Tax (AMT). If you are subject to the AMT, you’ll want to consider other alternatives first and make some comparisons. Even if you are subject to the AMT and can’t deduct the interest, it is possible that a home equity loan is still a good option due to low-interest rates available on this type of loan.

Education Loan

When considering an education loan, most people think of government-guaranteed student loans, but actually, there are many sources available to you as long as it is a single-purpose loan, that is, funds are used only for qualified educational purposes. Interest paid on education loans is an above-the-line deduction which means that you don’t have to itemize your deductions to claim this benefit. The maximum interest deduction per year is limited to $2500 which isn’t much when you consider that the average annual cost (tuition, room, and board) for undergraduates at public institutions is over $14,000 and prices increased 40% between 2001-02 and 2011-12.1 But, $2500 is better than nothing, and there is no reason to leave money on the table. Note that the deduction phases out for higher income married taxpayers with an AGI between $130,000 and $160,000. For singles, the phase-out range is between $65,000 and $80,000.

Other Loan Options

Many people turn to relatives or a qualified employer plan for education loans, and it is great to have these options, but just know that the interest paid on these loans will not qualify as deductible education interest. If you are considering pulling money out of a retirement account to pay for education expenses, I urge you to consider all other options first. Remember retirement account distributions are taxable and subject to early withdrawal penalties if you are under retirement age.

Please give me a call to discuss your education loan options, especially if you are considering tapping a retirement account.

1 HTTPS://nces.ed.gov/fastfacts/display.asp?id=76