Link to special CCH Tax Briefings on key topics from 2003:
 

• Year-End Tax Legislation Update (Dec. 10)
• Corporate Income Tax and 'Bonus' Depreciation
  (Dec. 4)
• Military Family Tax Relief Act (Nov. 11)
• Jobs and Growth Tax Relief Reconciliation Act of 2003 (May 28)

CCH can assist you with stories, including interviews with CCH subject experts. Also, the CCH Whole Ball of Tax 2004 is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Neil Allen
(847) 267-2179
allenn@cch.com

Taking Time to Study Education Credits, Deductions, Exemptions Can Be Worth the Effort

(RIVERWOODS, ILL., January 2004) – While there’s no single right or wrong answer for every family saving for a college education, there are several tax breaks they can take advantage of if they’re willing to do some up-front studying and number-crunching, according to CCH INCORPORATED (CCH), a leading provider of tax law information and software.

New to this year’s list of education tax breaks for higher education is the Independent 529 plan adopted by more than 200 institutions in late 2003.

"Policymakers continue to tweak the education savings options and available tax breaks for continuing education and related expenses. So even if you’re planning years ahead, it’s still a good idea to revisit the programs and rules each year," said John W. Roth, an attorney and federal tax law analyst for CCH.

And, while there are dozens of different incentives, not all students will benefit from all programs.

"Often, when you take advantage of one tax break, you may limit your ability to claim another. For example, if you take a certain deduction, you may not be able to use a corresponding credit or exclusion so you want to make sure you use the programs that will benefit you the most," Roth said.

Following is a look at the major provisions of each program. For more information, consult IRS Publication 970, Tax Benefits for Education, especially for the definition of modified adjusted gross income used to determine eligibility for many programs.

Coverdell Education Savings Account (ESA)

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.

Contribution limits: $2,000 maximum annual contribution per year per beneficiary.

Qualifying expenses: For both K-12 and post-secondary education, Coverdell ESAs can be used to pay for tuition and fees, books, supplies and equipment.

For K-12, it 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, it can cover expenses for room and board if the student is enrolled at least half-time and the amount meets certain guidelines.

Money from a Coverdell ESA also can be used to fund a qualified tuition program (529 plans).

2003 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.

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.

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.

Qualified Tuition Program (529 Plans)

What it is: Three general types of 529 plans now exist:

• Pre-paid tuition plans – the first of the qualified plans to be offered, these programs generally provide that if you invest a specific amount today, you will be guaranteed to have future tuition covered at a state school in the future. However, with increasing budget woes, many of these programs are freezing enrollment temporarily, increasing yearly contribution amounts, or imposing surcharge fees.

• State 529 college savings plans – generally sponsored by each state and run by professional third-party investment management firms allowing you to invest in mutual funds and use the proceeds in the future to attend a state or private university.

• Independent 529 plans – sponsored by a consortium of about 220 private colleges and universities and administered by Teachers Insurance and Annuity Association/College Retirement Equities Fund (TIAA-CREF), in which purchasers are able to lock in current tuition rates for future years at any of the participating schools.

  Each is a savings program in which investment earnings are not taxed if withdrawals are used for qualified expenses. Contributions to state-sponsored programs are either partially or fully deductible on some state tax returns. (Distributions from programs sponsored by educational institutions will be taxable if made before January 1, 2004.)

Contribution limits: 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: 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.

Contribution phaseout ranges: No income limitations.

Who can/can’t claim it: Someone funding a qualified tuition program for another individual can use the annual gift tax exclusion (currently $11,000) or combine five years’ worth of exclusions 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: 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.

"There’s a lot of confusion around the benefits of using 529 plans. Many people still are uncertain about the differences between the programs, the true tax savings they offer – particularly given that the maximum tax on capital gains from conventional investments has been reduced to 15 percent – or the future of the programs as some of the tax benefit features are set to expire after 2010, unless Congress renews them," said Roth.

Hope 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.

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.

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

Credit phaseout ranges: $41,000-$51,000 for single filers, $83,000-$103,000 for joint returns. For 2004, this range changes to $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.

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.

Lifetime Learning Credit

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

Credit amount: Beginning with 2003 returns, credit is 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.

Credit phaseout ranges: $41,000-$51,000 for single filers, $83,000-$103,000 for joint returns. For 2004, this range changes to $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 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 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

What it is: A deduction from gross income (an above-the-line deduction) of up to $3,000 based on expenses for post-secondary education.

Deduction amount: 100 percent of the first $3,000 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.

Deduction phaseout ranges: No phaseout, but a cut-off. Deduction is not allowed if modified adjusted gross income is greater than $65,000 for a single filer, $130,000 for a joint filer.

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.

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.

Student Loan Interest Deduction

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

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

Qualifying expenses: 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.

Deduction phaseout ranges: $50,000-$65,000 for a single filer, $100,000-$130,000 for a joint filer.

Who can/can’t claim it: 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.

What to watch out for: Must reduce qualified educational expenses by the total amount paid through tax-free sources such as tax-free withdrawals from Coverdell ESAs.

Teachers’ Classroom Expenses (Educator Expenses Deduction)

What it is: 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 $250 in qualifying expenses. Taken on Form 1040A or 1040.

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

Deduction phaseout ranges: No income limitations.

Who can/can’t claim it: 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: Nonathletic supplies for courses in health or physical education do not qualify. This above-the-line deduction is set to terminate after the 2003 tax year, but Congress is likely to consider extending this deduction.

Several exclusions also are available for taxpayers including:

• All or part of the interest on proceeds of a qualified savings bonds (specifically, Series I bonds or qualified Series EE bonds issued after 1989) cashed to pay education expenses; eligibility phaseout ranges are $58,500-$73,500 for single filers, $87,750-$117,750 for joint returns.

• Employer-provided educational assistance (up to $5,250 annually) from income for undergraduate or graduate level coursework and expenses.

• Scholarship money or tuition reduction from income up to amount spent on qualified expenses; generally cannot claim exclusion if scholarship or tuition reduction represents payment for teaching, research or other services, but exclusion can be applied to Armed Forces and National Health Service Corps scholarship programs even though future service obligation is connected to them.

• The amount of a cancelled student loan from income (normally, a cancellation of indebtedness counts as income). The discharge must be made under the terms of a loan agreement and made because the person works for a specified period in certain professions for certain kinds of employers – for example, as a doctor or nurse in a rural area.

• Amounts paid to an educational institution on behalf of someone else from gift tax; payments made to a student or other individual do not qualify, even if the funds are ultimately used to pay tuition.

Other Provisions

Certain individuals also can realize tax breaks from claiming the job-related educational expense deduction or taking a penalty-free IRA withdrawal.

The job-related educational expense deduction is a miscellaneous itemized deduction for education that meets educational requirements for a current job or maintains and enhances skills for a current job. However, as a miscellaneous deduction, only the amount in excess of 2 percent of adjusted gross income is deductible. Use Schedule A, Form 1040.

The penalty-free IRA withdrawal allows individuals to escape the 10-percent penalty on early withdrawals from IRAs when the proceeds are used for educational expenses for self, spouse, child and grandchild. Withdrawals are generally subject to income tax. Income tax does not apply, however, to withdrawals from Roth IRAs up to the amount contributed to the account.

About CCH INCORPORATED

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served more than four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, accounting, legal, securities and small business markets. CCH is a Wolters Kluwer company. The CCH Federal and State Tax group, CCH Tax Compliance and Aspen Publishers Tax and Accounting group comprise the new Wolters Kluwer Tax and Accounting unit. The unit’s web site can be accessed at tax.cchgroup.com.

-- ### --

nb-04-17