2005 CCH Whole Ball of Tax

Contact: Leslie Bonacum, 847-267-7153, mediahelp@cch.com
Neil Allen, 847-267-2179, allenn@cch.com

Coverdell Education Savings Account (ESA)

Qualified Tuition Program (529 Plans)

What it is:

A savings account for educational expenses in which earnings grow tax-free. Withdrawals also are tax-free if used to pay for qualified educational expenses.

Three general types of 529 plans now exist:

• Pre-paid tuition plans – generally guaranteeing future tuition coverage at a state university.
• State 529 college savings plans – generally sponsored by a state allowing you to use saving plan proceeds to attend a state or private university.
• Independent 529 plans - sponsored by a consortium of private colleges, whereby you can lock in current tuition rates for future years at participating schools.

In each savings program, investment earnings are not taxed if withdrawals are used for qualified expenses. Contributions to state-sponsored programs are partially or fully deductible on some state tax returns.

Contribution limits:

$2,000 maximum annual contribution per year per beneficiary.

Contributions cannot be more than is necessary to provide for the higher education expenses of the beneficiary. These amounts are set by the state or educational institutions sponsoring the plan and may be in excess of $250,000. In the case of Independent 529s, accounts can be opened with as little as $25, but must reach at least $500 within two years; and the maximum contribution amount is equal to five years of tuition based on other restrictions. There are no other specific annual contribution limits for the plans.

Qualifying expenses:

Can be used to pay for tuition, fees, books, supplies and equipment for both K-12 and post-secondary.

For K-12 can also pay for uniforms; transportation; supplementary items and services such as extended day programs; room and board; and purchase of computer technology and Internet access (but cannot be used for sports, games or hobby software unless it is predominantly educational).

For post-secondary education, can cover expenses for room and board if the student is enrolled at least half-time and the amount meets certain guidelines. Can also be used to fund a qualified tuition program.

Distributions can be used for books, supplies, equipment, room and board, transportation and other necessary expenses in addition to tuition, student activity fees and course-related fees paid directly to the educational institution.

2004 contribution phaseout ranges:

$95,000-$110,000 for single filers, $190,000-$220,000 for joint returns, no phaseout for corporation or other entities, including tax-exempt organizations.

No income limitations.

Who can/can’t claim it:

Beneficiary must be under 18 years old or be a special needs beneficiary in the year contributions are made.

Someone funding a qualified tuition program for another individual can use the annual gift tax exclusion (currently $11,000 or $22,000 for a couple) or combine five years’ worth of exclusions, up to $55,000 or $110,000, in a single year. The beneficiary can exclude funds withdrawn from the qualified program from income if they are used for qualified expenses.

What to watch out for:

Beneficiary is taxed on any withdrawals not used to pay for qualified educational expenses. (Penalty-free withdrawals can be made in connection with service academy appointments.) All funds must be withdrawn by the time beneficiary reaches age 30, but an account can be transferred from one beneficiary to another. All contributions must be in the form of cash. As with a conventional IRA, owner of the account can exercise wide discretion as to investments. The funds, however, cannot be used to reimburse the taxpayer for home schooling.

Check tax treatment of contributions for state income tax purposes. Limited ability to change investment options. Possible 10-percent penalty if distributions are not used for qualified expenses. Beneficiary can be changed if new beneficiary is a member of the same family. In the case of the Independent 529 plans, if your child does not attend a member college and you either withdraw the money or transfer it to a state-run plan, you won’t be able to collect more than a 2-percent gain on the money you invested – even if the return you realized was in excess of this. Penalty-free withdrawals can be made in connection with service academy appointments.

Hope Credit

Lifetime Learning Credit

What it is:

A credit of up to $1,500 per student based on expenses in the first two years of post-secondary education.

A credit of up to $2,000 per return based on expenses for post-secondary education or courses to improve job skills.

Credit amount:

100 percent of the first $1,000 in qualifying expenses plus 50 percent of the next $1,000 in qualifying expenses. Use Form 8863.

20 percent of first $10,000 in qualifying expenses, to a maximum $2,000 credit. Use Form 8863.

Qualifying expenses:

Tuition, student activity fees and course-related fees paid directly to the educational institution.

Tuition, student activity fees and course-related fees paid directly to the educational institution.

Credit phaseout ranges:

$42,000-$52,000 for single filers, $85,000-$105,000 for joint returns.

$42,000-$52,000 for single filers, $85,000-$105,000 for joint returns.

Who can/can’t claim it:

Can’t be taken if married filing separately. Can’t be taken by student claimed as dependent child on another person’s return, but parent can claim credit for paying dependent child’s expenses. Student must be enrolled in program leading to degree or other recognized credential, studying at least half-time.

Can’t be taken if married filing separately. Can’t be taken by a student if claimed as dependent child on another person’s return, but parent can claim credit for paying dependent child’s expenses.

What to watch out for:

Can’t be taken if lifetime learning credit or tuition and fees deduction is taken for the same student.

Can be taken in same year as a distribution from a Coverdell Education Savings Account (ESA) or qualified tuition program, but not for same expenses. Can be taken for expenses paid for with student loan.

Can’t be taken if Hope credit or tuition and fees deduction is taken for the same student.

Can be taken in same year as a distribution from a Coverdell ESA or qualified tuition program, but not for same expenses. Can be taken for expenses paid for with student loan.

Tuition and Fees Deduction

Student Loan Interest Deduction

Educator Expenses Deduction

What it is:

A deduction from gross income (an above-the-line deduction) of up to $4,000 based on expenses for post-secondary education.

A deduction from gross income of up to $2,500 based on interest paid on a student loan for post-secondary education.

The ability of teachers to take an above-the-line deduction based on amounts they spend for unreimbursed classroom expenses.

Deduction amount:

100 percent of the first $4,000 in qualifying expenses. Taken on Form 1040A or 1040.

100 percent of the first $2,500 in qualifying expenses. Taken on Form 1040A or 1040.

100 percent of the first $250 in qualifying expenses. Taken on Form 1040A or 1040.

Qualifying expenses:

Tuition, student activity fees and course-related fees paid directly to the educational institution.

Loan may cover books; supplies; equipment; room and board; transportation; and other necessary expenses in addition to tuition; student activity fees and course-related fees paid directly to the educational institution. Interest payments are deductible for the entire period of the loan.

Unreimbursed expenses in connection with books, supplies, computer equipment and supplementary materials used in the classroom.

Deduction phaseout ranges:

Deduction is only allowed if modified adjusted gross income is not greater than $65,000 for a single filer, $130,000 for a joint filer. Taxpayers whose income exceeds that limit but does not exceed $80,000 for a single filer or $160,000 for joint filers in 2004 and 2005 may deduct up to $2,000 in qualified expenses.

$50,000-$65,000 for a single filer, $100,000-$130,000 for a joint filer.

No income limitations.

Who can/can’t claim it:

Can’t be taken if married filing separately. Can’t be taken if claimed as dependent on another person’s return, but parent can claim credit for child’s expenses.

Must have been in degree program and at least half-time student to take the deduction. Can’t be taken if married filing separately. Can’t be taken if claimed as dependent on another person’s return. Can only be taken by the person who is responsible for the loan and who actually makes the payments.

Teachers, instructors, counselors, principals and aides who work for at least 900 hours during a school year in school that provides elementary or secondary education as determined by state law.

What to watch out for:

Can’t be taken if Hope or Lifetime Learning credit is taken for the same student. This above-the-line deduction is set to terminate after 2005. Can be taken in same year as a distribution from a Coverdell ESA or qualified tuition program, but not for same expenses. Can be taken for expenses paid for with student loan.

Must reduce qualified educational expenses by the total amount paid through tax-free sources such as tax-free withdrawals from Coverdell ESAs.

Nonathletic supplies for courses in health or physical education do not qualify. This above-the-line deduction was extended for 2004 and 2005 under the Working Families Tax Relief Act of 2004.