2008 CCH Whole Ball of Tax

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2008 CCH Whole Ball of Tax

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

Section 529 Plans Become More Attractive As Kiddie Tax Limits Education Savings Options While Other Education Deductions Expire for 2008

(RIVERWOODS, ILL., January 2008) – After being made permanent in 2006, Section 529 college saving plans may be gaining even greater value among families that had been using the kiddie tax loophole as a preferred college savings strategy, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). Meanwhile, congressional inaction in 2007 may result in further restriction of off-setting education expenses with the expiration of two popular tax breaks: the above-the-line deduction for higher education and the educator’s expense deduction.

“Higher education continues to get more costly and families need to figure out early on how they’re going to pay for tuition,” said CCH Senior Federal Tax Analyst John W. Roth, JD, LLM. “Unfortunately, those who had been bankrolling their child’s or grandchild’s accounts with appreciated assets, planning to then sell those assets at the child’s reduced tax rate to pay for college no longer have that option.”

A change in the tax law last year now provides that children through age 18 (or 23 if a full-time dependent student) will have their investment income taxed at their parents’ top tax rate starting in 2008, which currently is 15 percent versus the potential child’s tax rate of zero percent.

With fewer options, more families are likely to turn to qualified tuition plans, which include 529 college savings plans and prepaid tuition plans both of which are tax-advantaged savings options available 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.

Thirty-one states and the District of Columbia now provide that contributions to their state-sponsored programs may be partially or fully deductible by residents on their state tax returns. These states are: Arizona, Arkansas, Colorado, Connecticut, Georgia, Idaho, Illinois, Iowa, Kansas, Louisiana, Maine, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Virginia, West Virginia and Wisconsin. Two additional states – Indiana and Vermont – do not allow tax deductions but do offer tax credits to residents participating in their state’s college savings plan. The extent of the tax breaks varies from state to state. For example, New Mexico, South Carolina and West Virginia allow deductions for the full amount of the contribution.

Most states allow taxpayers to use 529 funds to pay for education in other states and while taxpayers are generally free to open up a plan in any state, they only get the tax advantage if they file a tax return in that state. So, for example, grandparents living in Georgia who want to help pay for education expenses for a grandchild living in Wisconsin planning to go to a Wisconsin state school would likely be better off from a tax perspective to open a 529 plan account in Georgia, take the Georgia state tax deduction for the amounts contributed, but then use the distributions to pay for qualified education expenses to the grandchild’s school in Wisconsin.

Ten states also provide state matching grants, including Colorado, Florida, Kansas, Louisiana, Maine, Michigan, Minnesota, North Dakota, Pennsylvania and Rhode Island. However, these grants require that the money be used by the beneficiary to attend a state school.

An additional benefit of 529 plans is that they allow taxpayers to change beneficiaries to another family member.

“If you were saving with the intention of your oldest child going to an exclusive private school, and she ends up selecting an in-state public university that costs considerably less, you can designate one of your other children as the beneficiary and boost their education savings,” said Roth.

However, 529 plans only allow transfer of beneficiary to an immediate family member and the funds must be spent by the time the beneficiary turns 30 years old. If there are no other children to name beneficiary after the last one reaches age 30, then taxes will be owed on the distribution and there will be a 10-percent penalty for withdrawing the funds for non-qualified use.

“Most families are struggling to save enough, so it’s unlikely many will find themselves in this situation,” said Roth. “However, if you have multiple individuals establishing 529 plans on behalf of a limited number of children, it’s worth discussing and setting guidelines to make the most of your investment and avoid unnecessary taxes and penalties.”

Above-the-line and Educator Expense Provisions Expire After 2007

In late 2006, Congress managed to sneak in extensions for the above-the-line and educator expense deductions to apply for the 2007 tax year. However, lawmakers were unsuccessful in repeating this last-minute strategy in 2007. As a result, both the above-the-line higher education tuition deduction, allowing a deduction of up to $4,000, and the teacher’s classroom expense deduction, allowing a deduction of up to $500 for those teaching students K-12 will not be available for 2008 – at least not as of now.

“These deductions have been very popular and it’s not entirely impossible they won’t be attached to some legislation that gets passed this year and made retroactive to the first of the year,” said Roth. “So parents and teachers should plan for the worst that they won’t be available, but if I were an educator, I’d hold on to my receipts, just in case.”

Educating Yourself on Education Savings, Credits, Deductions, Exclusions

While there continues to be a variety of tax-advantaged options available to help lessen education costs, not all options are available to all individuals and, in some instances, choosing one option may preclude you from choosing others. Below CCH compares the more popular tax-related education options for 2006 and 2007 and identifies which forms to use to take the tax break.

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 $300,000. In the case of many 529s, accounts can be opened with as little as $25 and contributions as little as $15 per pay period.

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 accredited post-secondary 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 accredited post-secondary educational institution.

Contribution phaseout ranges:

The phaseout ranges from modified adjusted gross income (AGI) of $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 ($12,000 for single filers or $24,000 for joint filers for 2007 and 2008) 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:	For 2007, a credit of up to $1,650 (adjusted for inflation) per student based on expenses in the first two years of post-secondary undergraduate education; the credit amount increases to $1,800 for 2008.	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 2007: 100 percent of the first $1,100 in qualifying expenses plus 50 percent of the next $1,100 in qualifying expenses; the amount of tuition expenses eligible will increase to $1,200 for 2008. 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 2007: modified AGI: $47,000-$57,000 for single filers, $94,000-$114,000 for joint returns.

For 2008: modified AGI increases to: $48,000-$58,000 for single filers, $96,000-$116,000 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.

Credit applies per student.

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.

Credit applies per return.

'Above-the-line' Deductions

Barring new legislation, both the tuition and fees deduction and the educator expenses deduction expired at the end of 2007.

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 ($2,000 if modified AGI exceeds $65,000) 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:	Full deduction is only allowed if modified AGI for 2007 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 may deduct up to $2,000 in qualified expenses in 2007.	For 2007, modified AGI: $55,000-$70,000 for a single filer, $110,000-$140,000 for a joint filer For 2008, modified AGI: $55,000-$70,000 for a single filer, $115,000-$145,000 for a joint filer.	No income limitations.
Who can/can’t claim it:	Can be taken in 2007 by qualifying individuals. 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 in 2007 and only by teachers, instructors, counselors, principals and aides who work for at least 900 hours during a school year in a 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 qualified savings bonds (specifically, Series I bonds or qualified Series EE bonds issued after 1989) cashed to pay education expenses; 2007 modified AGI eligibility phaseout ranges are $65,600–$80,600 for single filers, $98,400–$128,400 for joint returns; and increase for 2008 to $67,100–$82,100 for single filers, $100,650–$130,650 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 the 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.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit 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, CorpSystem™, 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 global information services and publishing company. The company provides products and services for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has 2006 annual revenues of €3.4 billion, employs approximately 18,450 people worldwide and maintains operations across Europe, North America, and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. For more information, visit www.wolterskluwer.com.

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nb-08-05