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Tax Advice for College Financing
- Hope Credit - A tax credit of up to $1,500 per student is available for the first two years of college education. The tax credit is 100% of the first $1,000 of any tuition and eligible class fees paid, and 50% of the second $1,000 in tuition and class fees paid (maximum of $1,500). Athletic fees, housing costs, student activity fees and books are not eligible expenses for the Hope or Lifetime learning credits. The credit phases out for married taxpayers with adjusted gross income between $87,000 and $107,000. For single taxpayers and others not filing a joint tax return, the adjusted gross income phase out is between $43,000 and $53,000.
- Lifetime Learning Credit - A tax credit of up to $2,000 per student is available for any college tuition paid during a year that the Hope credit is not claimed. The credit is 20% of any tuition or class fees paid up to $10,000 (for a total allowable credit of $2,000). The lifetime learning credit has the same adjusted gross income and eligible expense limitations as the Hope credit.
- Up to $4,000 in education expenses can be deducted on your tax return if your modified adjusted gross income (MAGI) is not more than $80,000 ($160,000 on a joint return). If you choose to deduct the education expenses, you can not take the Hope or Lifetime Learning Credit on the same student's education expenses. It depends on each taxpayer's circumstances whether it is better to deduct the education expenses or take the Hope or Lifetime Learning Credit. Tuition and fees paid for the education of the taxpayer, the taxpayer's spouse or a dependent child are eligible for the deduction.
- Financial aid planning for college is often more important than tax planning. Steps can be taken to increase your child's chances of receiving grants or a subsidized Stafford loan by decreasing the child's income and assets. This should be done the year before you apply for loans or grants.
Some specific financial-aid strategies are:- Shift investment assets from your child to you. The student's assets are a much bigger factor in the financial aid formula than the parents assets
- Move investment assets that produce interest and dividends into growth investments
- If you control a C corporation, reduce your salary and keep the money in the corporation until after your child leaves school
- Have two or more family members attend college at the same time
- If you own Series EE Savings Bonds, you may be able to redeem the bonds tax-free when you use the money to pay for college tuition in the year of redemption. However, any tuition costs that are used in the calculation of the Hope or lifetime learning credits cannot be included in determining whether the Series EE bond redemption is tax-free.
- Buy a condominium for your child to use at college. You can deduct the mortgage interest for your primary residence and one other home, so if you don't already have a vacation condominium or other second home that you are deducting mortgage interest on, a college condominium may make sense to invest in. You will be able to deduct the mortgage interest and property taxes as well as gain on any appreciation (hopefully) during the four or five years the child is at college.
- If you are not fully utilizing all of your IRA contributions for your own retirement, one of the best college investment strategies is to use a Roth or traditional IRA to fund your child's education. You, your spouse, and your child (if he or she has earned income) can each put $3,000 per year into an IRA and distribute the IRAs penalty-free to be used for qualifying education costs. The Hope and lifetime learning credits are unaffected by IRA distributions. Also, if your child decides not to go to college, you will not be penalized or lose out on earnings. CAUTION: You need to wait until the end of the fifth year after you made your first Roth IRA contribution before taking a distribution from your Roth IRA.
- If your child has $3,000 in earned income, you may want to gift $3,000 to the child to put into the child's own IRA for college education funding.
- Consider a qualified state tuition program. www.savingforcollege.com has a great analysis of all the different states that offer qualified tuition programs. States such as New Hampshire and Utah allow residents and nonresidents alike to participate in their program and attend college anywhere in the United States. The tax advantage is that the investment grows tax-deferred until the child goes to college and the child will usually be in the lowest tax bracket when income on the accumulated earnings does have to be recognized upon distribution of the earnings to pay for college. Qualified state tuition programs are great for high-income taxpayers and people who want to invest large amounts for their child or grandchild's education. Some states also offer tax breaks for residents of their state. Some states do not have very good qualified tuition programs, so check out your state's program at www.savingforcollege.com, then check out other states programs that allow for nonresident participation.
- If you have appreciated investments, you may want to give them to your child to sell and use for college. If your child is in the 15% tax bracket, he or she will only pay a 10% tax on the gain instead of the 20% tax you would pay if you sold the investment and gave the child the cash. However, if your child is going to qualify for financial aid, giving them investments may disqualify them from receiving the financial aid.
- If your child is a full-time student younger than age 24, you can still claim your child as a dependent on your tax return. The education credits, Lifetime Learning Credit or Hope Credit, go onto your tax return if you claim your child as a dependent. If your child claims his own exemption on his tax return, then the education credit goes on your child's tax return. It doesn't matter who actually paid the tuition, the education credits go on the tax return where the child's exemption is claimed. Usually the most tax benefit is received by the parents claiming the dependent and education credit, but if the parent's income is too high to take advantage of the education credit, the child may benefit more by claiming their own exemption and education credit. The child would have to have enough income to have a tax liability to get any benefit from the education credit. The education credit is not a refundable credit, so if the child has low income and has no tax to begin with, then the education credit doesn't do them any good.
