As you send your children off to college and pay the bills for their tuition, fees and other expenses, do you know what type of educational benefits are available at the federal level to help with these costs? The three main types are credits, deductions and savings plans. Respectively, these benefits can reduce the amount of tax owed, reduce the amount of income subject to tax or provide an avenue to grow contributions that could be tax-free.
The American Opportunity Credit is available through December 31, 2012, and provides a maximum credit of $2,500 per student, calculated as 100 percent of the first $2,000 spent on qualifying expenses and 25 percent of the next $2,000 per student each year. The full credit is available for taxpayers making less than $80,000, or $160,000 for married couples filing a joint return, but is phased out as their income increases above these levels. Of the credit, 40 percent is refundable so even those who owe no tax can get up to $1,000 of the credit back in cash. This credit is eligible for qualified expenses incurred for the first four years of post-secondary education.
The Lifetime Learning Credit is available for those who are beyond their first four years of post-secondary education. There is no limit on the number of years this credit can be claimed. The maximum credit available is $2,000 and is 20 percent of the first $10,000 paid for qualifying expenses. As with the American Opportunity Credit, the amount of the credit is phased out as income exceeds $61,000 or $122,000 if married filing a joint return.
Based on your individual tax situation, the Tuition and Fees Deduction may provide a better benefit. This deduction allows you to reduce your income that is subject to tax by up to $4,000. The income limit to use this deduction is $80,000 or $160,000 if married filing a joint return, with ratable decreases to the deduction as income increases beyond these thresholds. It is important to consult your tax advisor regarding these options as you can choose the education benefit that provides the lowest tax.
If your children have not reached college age yet, you may want to consider opening a college savings plan. A savings plan, such as a 529 plan, allows you to prepay or contribute to an account for education expenses for a designated beneficiary.
Contributions are not deductible but the distributions are tax-free if they are used for educational expenses for the designated beneficiary. In addition, there are no income limits on individuals making the contributions.
Another savings plan option is a Coverdell Education Savings Plan. This plan allows contributions of up to $2,000 per year for those with income less than $110,000 or $220,000 if filing a joint return. These contributions can be used for K-12 education expenses or post-secondary expenses. The contributions grow tax free until distributed and only those distributions in excess of the qualified education expenses are taxable.
Email Rea & Associates to find out what amounts are qualified educational expenses, what records to maintain to support your educational benefits and guidance on how to determine the greatest benefit.
This article was originally published in Illuminations: Facts & Figures from people with a brighter way, a Rea & Associates enewsletter, 8/29/2012.