 |
CCH can assist you with stories, including interviews with CCH subject experts.
Also, the 2006 CCH Whole Ball of Tax is available in print. Please
contact:
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
Neil Allen
(847) 267-2179
neil.allen@wolterskluwer.com
Link to special CCH Tax Briefings on key topics from 2005:
|  |
2006 CCH Whole Ball of Tax
Tax-advantaged Education Savings Across the Generations
Finding the Tax Savings for Students,
Parents, Grandparents
(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
Scholarships and Fellowships
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.
Student Loans
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
Investment Savings 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.
Education and Retirement Account Options
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 12th 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.”
Deductions and Credits
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.
Savings Vehicles
|
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.
|
Tax Credits
|
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.
|
‘Above-the-line’ Deductions
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.
|
Exclusions
Several exclusions also are available for
taxpayers related to education including:
- Bond interest: 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; 2005 modified
AGI eligibility phaseout ranges are $61,200-$76,200 for single filers,
$91,850-$121,850 for joint returns; and increase for 2006 to $63,100-$78,100
for single filers, $94,700-$124,700 for joint returns.
- Employer assistance: Employer-provided educational assistance (up
to $5,250 annually) from income for undergraduate or graduate level coursework
and expenses.
- Scholarship funds: 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.
- Student loans: 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.
- Gifts: 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.
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.
-- ### --
nb-06-25
|
|
|
|