Randy J. Elder, CPA, P.C.

The other (tax) benefit of higher education

Education and Tax Benefits

Seems like I was just commenting on the fact that it was the start of summer vacation season and then, as soon as I turn around, August is here. For many, August means it is time to think ‘back to school’. As such, it seems like a good time to talk briefly about the other (tax) benefits of pursuing higher education.

You might have children or even grandchildren heading off to school soon. Or maybe you or your spouse is pursuing additional education. The good news is that this is one area in the tax code that includes a number of incentives that can provide tax benefits.

Here is a quick rundown of tax benefits offered in the current tax code. If you or a family member is pursuing additional education, you’ll want to review to see if you qualify and see how to structure your education finances to reap the greatest tax benefit.

How will you pay for Education expenses? One of the first and most important decisions is to determine how you will finance education expenses.

Savings programs. If you have the advantage of making a long-term plan, there are savings programs such as a Coverdell account or Sec. 529 plan. Since I’ve covered those in previous blog posts I won’t elaborate here. If you are interested in finding out more about the Sec. 529 plan, go to my post. To read more on the Coverdell account go to my back to school blog post.

Financing programs. If you find that borrowing money is the way you need to go, you might want to review the pros and cons of financial aid vs. a home equity loan. Advantages of home equity loans include lower interest rates, longer terms and lower payments vs. financial aid. In addition to rate, term and payment, you’ll also want to look at the differences when it comes to deductions.

Interest on home equity debt is deductible only if you itemize and then only on the first $100,000 of debt. If you are taxed by the alternative minimum tax, there is no deduction.

When it comes to student loans, to qualify for a deduction the loan must be single-purpose. The interest deduction is limited to $2,500 per year, and the deduction phases out for joint filers with income (MAGI) between $130,000 and $160,000 ($65,000 to $80,000 for unmarried taxpayers, and no deduction if filing married separate).

In addition to deductions, the tax code also allows for certain tax credits for post-secondary education tuition. There are two types of credits: the American Opportunity Credit and the Lifetime Learning Credit. The American Opportunity Credit is available only for the first four years of post-secondary education. For education beyond the first four years, the Lifetime Learning Credit kicks in.

In general, the American Opportunity Credit offers more tax benefits than other programs. Here are some of the more important features;

* It goes beyond tuition to include related fees, books, and other required course materials. The credit is equal to 100 percent of the first $2,000 of education expenses and 25 percent of the next $2,000. If you pay $4000 or more in qualified expenses for an eligible student, and that is not hard to do, the full $2500 credit may be available to you.
* To qualify for the full credit amount, your modified adjusted gross income (MAGI) must be $80,000 or less (for married couples filing a joint return, the limit is $160,000 or less). For taxpayers with incomes above these levels, the credit is phased out.
* Forty percent of the American Opportunity Credit is refundable. This means that even people who owe no tax can get an annual payment of the credit of up to $1,000 for each eligible student. This feature is unique to the American Opportunity Credit.

Under the Lifetime Learning Credit program, taxpayers can receive up to $2,000 of credit for each family each year. The Credit is phased out for joint filers with incomes (MAGI) for 2014 between $108,000 and $128,000 ($54,000 to $64,000 for single filers). If you are married filing separately, the credit is not allowed.

Savings Bond Program: We may not always think of savings bonds but it is worth mentioning that there is an education-related exclusion of savings bond interest. This exclusion is specific to Series EE or I Bonds purchased by an individual over the age of 24. To be eligible for the tax benefit, qualified higher education expenses must be paid in the same year the bonds are redeemed. The tax benefit is phased out for joint filers with income (MAGI) between $113,950 and $143,950 (between $76,000 and $91,000 for unmarried taxpayers). Similar to many of the other programs, this exclusion is not available to those using the married separate status.

As a tax professional I am big on upfront planning to maximize tax savings for my clients and education expenses are no exception. With careful planning qualifying expenses for higher education can provide substantial tax benefits. In addition to the benefits mentioned above, you are also allowed to prepay the first three months of the subsequent year’s tuition in advance. With proper planning you can spread the payment and maximize the tax benefits.

If you would like to work out a comprehensive plan to take advantage of these benefits, please give me a call.