Higher education is costly—so take advantage of every tax break that can soften the expense! Here are a bunch of provisions that can do just that (with thanks to my partner Brian Lovett, CPA, JD, for helping me explain these tax breaks to my readers). As always, check in with your own tax advisor to make sure any of these strategies work in your particular situation…
Section 529 plans allow contributions to accumulate tax free and remain tax free so long as distributions are used for qualified education expenses at an eligible institution, which include colleges and public, private and religious elementary and secondary schools. There is no limit to the amount of distributions for college costs, which can include tuition, fees, room and board, books, supplies and equipment required for enrollment, but there is a $10,000 annual distribution limit for elementary and secondary school costs. There is no age limit for the recipient’s benefit of the distributions.
Rollovers can be made from a 529 plan to a 529A plan—also called an “ABLE” plan and limited to disabled beneficiaries—provided the ABLE meets the requirements for rollovers.
Certain states also allow limited deductions for contributions to 529 plans. Check with your state for eligibility for this deduction. Annual contributions are gift-tax free up to $15,000 per person (doubled with a consenting spouse), and five years’ contributions can be made at one time permitting up to $150,000 to be contributed and start earning tax-free income.
Coverdell Education Savings Accounts (ESAs) also permit contributions to grow tax free and permit qualified tax-free distributions similar to 529 plans. The annual contribution limit is $2,000 per year per child, and contributions can be made while the student is under age 18. Funds within the plan must be disbursed before the beneficiary reaches age 30. Contributions are subject to adjusted gross income limitations. ESAs can be used along with 529 plans.
Higher-education credits. There are two credits for higher-education costs, and eligibility is subject to adjusted gross income limits. Both the American Opportunity Tax Credit (“AOTC”) and the Lifetime Learning Credit (“LLC”) cover tuition and fees, but the LLC permits other expenses to qualify. If the expenses eligible for the AOTC or LLC are paid by a parent who cannot claim it on their return because of income limitations, the credit can be claimed on the child’s return if that would result in a tax benefit to the child. The American Opportunity Tax Credit is available during the first four years of college and offers a credit up to $2,500 per eligible student. Forty percent of this credit is refundable (maximum $1,000) if tax is reduced to $0. The Lifetime Learning Credit is $2,000 per tax return, is not refundable, and applies to all years of schooling including professional degree courses. There is no limit on the number of years a taxpayer can claim the LLC.
An exemption of $4,050 on your 2017 tax return can be claimed for a child who is a full-time student under age 24 provided he/she did not file a joint return with a spouse. Exemptions have been eliminated for tax-year 2018.
A Savings Bond interest exclusion permits an exclusion from taxation of interest earned on the redemption of eligible Series EE and I bonds issued after 1989 that are used for post-secondary educational costs. Eligibility rules and adjusted gross income limits must be met and should be reviewed with a tax advisor before withdrawals or investments are made.
Gift Tax. Tuition payments on behalf of a student that are paid directly to the school are not subject to gift tax. Conversely, a payment to the student or parent who then remits it to the institution will be subject to the gift tax. Payments for room and board, books and other costs are subject to the gift tax even if made directly.
IRA withdrawals to pay for college and room and board are not subject to the penalty for premature distributions if they meet the eligible use limitations at the time of the withdrawal.
Student loan interest of up to $2,500 per year is deductible subject to a phaseout based on adjusted gross income.
Income from the discharge of student debt after December 31, 2017 because of death or disability is not taxable.
Qualified employer educational assistance plans can provide up to $5,250 in tax-free benefits to an employee regardless of whether the education is job-related.
Miscellaneous itemized deductions can be taken for certain educational expenses for the 2017 tax year. (Though these disappear with the 2018 tax year under the new federal tax overhaul.) For 2017, these include job related educational costs and travel.
Qualified scholarships and fellowships aren’t taxable if they meet the appropriate provisions—generally if they pay the cost of tuition, books, fees and other necessary expenses, but not including room and board. A school’s tuition reduction for employees and their dependents for undergraduate courses is not taxable. Under certain circumstances, tuition reduction for graduate students engaged in teaching or research can be tax-free. Payments for teaching and research as a condition of receiving the benefits are taxable, again with certain exceptions.
The above presents some of the more popular tax benefits for educational costs—almost everyone can use at least a few of them. Like all tax maneuvers, prior to any action, these should be discussed with a tax professional who can apply the laws to your specific situation. Good luck!