CCH INCORPORATED

(RIVERWOODS, ILL., January 2006) – Costs for higher education continue to climb while federal sources of aid are being curtailed. As a result, savings for college is increasingly becoming a family affair, involving the parents, child, and grandparents, and while payment methods abound, some have far greater tax advantages than others, according to CCH, a Wolters Kluwer business and a leading provider of tax and accounting law information, software and services (tax.cchgroup.com).

“Saving for higher education is now getting almost as complex as saving for retirement, with a myriad of options and sources, which have to be evaluated and re-evaluated as a child approaches his or her college years,” said CCH Tax Analyst John W. Roth, JD, LLM.

Below, CCH reviews some of the different methods students, parents and grandparents can use to save and pay for college, and their implications when it comes time to pay taxes. A chart depicting many of the more common savings, credit and deductions follows.

Student Contributions: It’s More Than Showing Up for Class

Funds from scholarships and fellowships are tax-free if the recipient is enrolled in a degree program at an eligible school and the funds are being used to pay for qualified tuition and related expenses (e.g., fees, book supplies, etc.). If the funds are used to pay for living expenses such as room and board or travel that aren’t required for enrollment, then you must pay taxes on the funds. Taxes also must be paid on any income received for teaching, research or other services that the student carried out as part of the scholarship requirements.

An above-the-line deduction of up to $2,500 is available for interest paid on education loans for higher education. For 2005, the full deduction amount is available for single filers earning less than $50,000 and joint filers earning less than $105,000. The deduction is reduced ratably until income reaches $65,000 for single filers and $135,000 for joint filers, when it is completely lost. Student loans also can be taken out by a spouse or parent (as long as the student was a dependent when the loan was issued). From a tax perspective, students just entering the workforce and, therefore, likely to have a lower income level are likely better positioned to be eligible to take the deduction.

Parents – Where to Save and Credit/Deduction Options

Qualified tuition plans, for example 529 college savings plans and prepaid tuition plans, are tax-advantaged savings open to anyone regardless of income. With prepaid tuition programs, the taxpayer is allowed to pay for a designated beneficiary’s future college education using current-year dollars. With 529 plans, a taxpayer opens a savings plan sponsored by a state that allows proceeds to be used to attend a state or private university. Contributions to state-sponsored programs may be partially or fully deductible on state tax returns. For example, Colorado, Illinois, New Mexico, South Carolina and West Virginia allow deductions for the full amount of the contribution (in Illinois this applies only to the savings plan). Eighteen other states and the District of Columbia offer deductions on some portion of the contribution.

“Qualified tuition plans do offer tax-advantaged savings, but just like any investment, individuals need to look at the overall return, not just the tax savings,” said Roth. “States’ plans are often locked in with a particular brokerage house’s fund for a fixed period of time and investors are only allowed to change investment options once a year. As a result, there’s less flexibility than in traditional mutual fund investments, leading some individuals to split their savings between tax-advantaged 529 plans and income and growth mutual funds.”

Another savings option is the Series EE U.S. savings bond. Among the first education-specific savings vehicle when introduced in the late 1980s, it allows taxpayers to exclude from income the accrued interest from the bond if they redeem the bond and use the proceeds that year to pay for qualified education expenses for themselves, a spouse or child. However, as of May 1, 2005, Series EE bonds have a fixed interest rate tied to their date of purchase rather than a rate that adjusts every six months as in the past. With interest rates on the upswing and other investment options offering a greater return, these newer Series EE bonds have consequently fallen out of favor as an effective education savings tool.

The Coverdell Education Savings Account (ESA) – previously known as Education IRAs – allows earnings to grow tax-free if used to pay for qualified education expenses, which can include education for both kindergarten through 12^th grade and higher education. If used for college, it can be used to cover traditionally qualified education expenses and also room and board if the student meets certain guidelines. With a maximum savings of $2,000 per beneficiary per year, phasing out at $110,000 for single filers and $220,000 for joint filers in 2005, a Coverdell ESA is generally viewed as a way of chipping away at future college debt, but can only help make a real dent in college costs if used in addition to other savings options.

Even if you are under the age of 59 ½, you can take distributions from a traditional individual retirement account (IRA) to pay for qualified higher education expenses in the year in which the expenses are incurred, although any amount withdrawn must be included as taxable income. If you use the distribution for non-qualified expenses or expenses outside of the taxable year in which you tapped your IRA, you could be subject to a 10-percent penalty. Tapping your IRA should be an option of last resort, however.

“When you use your retirement funds to pay for education, you’re losing the tax-free interest and the compounding benefits, which you can never replace,” said Roth. “There are a lot of other options out there that should be evaluated before this is considered.”

Once your child actually makes it to college, tax deductions and credits become available to help lower the costs of the college years.

Both the Hope Scholarship and Lifetime Learning credits can be used to help offset the costs of qualified tuition and expenses and can be claimed by either the parent or the student (if they are not claimed as a dependent by a parent), but not both. The maximum amount of the Hope Scholarship credit is $1,500 per student (to increase to $1,650 for 2006) based on expenses in the first two years of higher education, while the maximum amount of the Lifetime Learning credit is $2,000 per taxpayer return based on expenses for higher education or for courses to improve job skills.

For 2005, the adjusted gross income phaseout range for both credits is $43,000 to $53,000 for single filers and $87,000 to $107,000 for joint returns (2006 phaseout ranges increase to $45,000 to $55,000 for single filers and $90,000 to $110,000 for joint filers).

An above-the-line deduction for qualified college tuition and fees of up to $4,000 also is available to taxpayers with a 2005 adjusted gross income of less than $65,000 for single filers and less than $130,000 for joint filers. Taxpayers who make more than this, but less than $80,000 as a single filer or $160,000 as joint filers can deduct up to $2,000. This deduction expired on 12/31/05 and is not available in 2006; although Congressional action to reinstate the deduction is pending.

However, credits and deductions can’t all be taken at the same time. A taxpayer must choose to take either the Hope Scholarship credit or the Lifetime Learning credit for a particular student, or they can choose to take the above-the-line deduction. Additionally, while the education deduction or either of the credits can be taken in the same year as a distribution for a Coverdell ESA or qualified tuition plan, they can’t be taken to cover the same expenses, although they can be taken for expenses paid for with a student loan.

“These are the types of issues that really have to be worked through and revisited at tax time to determine which options at that given point in time are going to be the most advantageous in helping to maximize your education investments and lower your tax bill,” said Roth.

Grandparents Begin to Weigh in

For grandparents looking to help pay for college, understanding the gift tax exclusion and estate tax rules is essential to get the biggest tax-free bang for their investment. The gift tax rules allow a taxpayer to make a gift of up to $11,000 ($22,000 for joint filers) each year to a recipient with the donor not being required to pay taxes on the gift (2006 gift tax exclusions increase to $12,000 for single filers and $24,000 for joint filers).

In the case of qualified tuition plans, a grandparent or other donor can choose to have a contribution treated as if it were made over five years beginning in the year the contribution was made. This allows a grandparent to contribute up to five times the annual gift tax exclusion rate with no gift tax consequences. However, if the grandparent dies during that five-year period, the part of the contribution that has not been allocated to years prior to death would be included and taxable under the grandparent’s estate.

An unlimited gift tax exclusion also exists for direct payments of education expenses. As a result, a grandparent can directly pay tuition bills – regardless of their amount – and not worry about any gift tax exposure or added tax obligation to the student, as tuition paid directly to the institution is not seen as the student’s taxable income. But, to qualify, the payment must be made directly to the education institution and only applies to tuition and fees, not to books, room and board or other living expenses. If made to the student or other family members to reimburse for or pay the tuition costs, the money is subject to both the traditional gift tax exclusion limits and, beyond this, treated as taxable gift of the donor.

Grandparents also can prepay tuition for their grandchildren to a particular institution for specific school years, both ensuring that the funds are free of gift tax and do not become subject to estate tax should the grandparent die before the child completes that school year. If the child does not complete the specified school year at the specified school, the money is not refundable to the child or family.

Side-by-side Comparison of Common Savings, Credits, Deductions, Exclusions

CCH compares the various tax-related education options for 2005 and the changes for 2006.

	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 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. As with IRAs, contribution can be made up to April 15 of following year. Can contribute to both a Coverdell ESA and a qualified tuition plan in the same year.	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; and student activity fees and course-related fees paid directly to the educational institution.
Contribution phaseout ranges:	For 2005, modified adjusted gross income (AGI): $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. Phaseout is not income adjusted, and reverts to 2001 levels after 2010.	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. Anyone can set up an account for a beneficiary as long as the annual contribution limits for that beneficiary are not exceeded.	Someone funding a qualified tuition program for another individual can use the annual gift tax exclusion ($11,000 for single filers or $22,000 for joint filers for 2005 and increasing to $12,000/ $24,000 for 2006) 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:	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, for example, Annapolis or West Point.) All funds must be withdrawn by the time beneficiary reaches age 30 (except if special needs individual), 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, for example, Annapolis or West Point.

	Hope Credit	Lifetime Learning Credit
What it is:	A credit of up to $1,500 (adjusted for inflation) per student based on expenses in the first two years of post-secondary undergraduate 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:	For 2005: 100 percent of the first $1,000 in qualifying expenses plus 50 percent of the next $1,000 in qualifying expenses (increases to $1,650 for 2006). 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:	For 2005 modified AGI: $43,000-$53,000 for single filers, $87,000-$107,000 for joint returns; For 2006 modified AGI increases to: $45,000-$55,000 for single filers, $90,000-$110,000 for joint returns.	Same as Hope credit.
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 used for graduate or professional level programs.	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 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.

Both deductions for Tuition and Fees and for Educator Expenses expired as of 12/31/05. However, both also have been included in the extender tax bills being evaluated in Congress.

	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 ($500 for joint filers who are both qualified educators). 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 AGI 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.	For both 2005 and 2006 modified AGI: $50,000-$65,000 for a single filer, $105,000-$135,000 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 be taken only by the person who is responsible for the loan and who actually makes the payments.	Can be taken only by 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. 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. Deduction is not available on Form 1040EZ.	Must reduce qualified educational expenses by the total amount paid through tax-free sources such as tax-free withdrawals from Coverdell ESAs. Deduction is not available on Form 1040EZ.	Nonathletic supplies for courses in health or physical education do not qualify. Deduction is not available on Form 1040EZ.

Several exclusions also are available for taxpayers related to education including:

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (tax.cchgroup.com) is a leading provider of tax, audit and accounting information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® Tax Research Network™, Accounting Research Manager™ and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading multinational publisher and information services company. Wolters Kluwer has annual revenues (2004) of €3.3 billion, employs approximately 18,400 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands (www.wolterskluwer.com). Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

2006 CCH Whole Ball of Tax

Tax-advantaged Education Savings Across the Generations

Finding the Tax Savings for Students, Parents, Grandparents

Student Contributions: It’s More Than Showing Up for Class

Parents – Where to Save and Credit/Deduction Options

Grandparents Begin to Weigh in

Side-by-side Comparison of Common Savings, Credits, Deductions, Exclusions

About CCH, a Wolters Kluwer business