Tax benefits for financing education

As children return to school and kids head off to college I thought that it would be a good time to discuss federal tax incentives for higher education.

I think we all agree that the cost of higher education is out of control, and many are beginning to question the actual value of receiving a higher education. With my oldest going off to college this fall, and three more in the pipeline I have a newfound appreciation for what many are experiencing.

Fortunately, the federal government has a number of various incentives to help reduce the strain that families encounter in trying to pay for higher education.

Several of these tax savings opportunities involve tax advantaged savings opportunities that can be initiated long before the student actually begins their higher education.

The 529 Plan is the most common of these in which earnings grow tax deferred and distributions are tax free when used for qualified post-secondary educational expenses.

Some lesser known tax advantaged savings opportunities for higher education include the use of U.S. Savings Bonds and the Coverdell Education savings accounts.

United States EE and I bonds purchased after 1989 by someone at least 24 years old can be redeemed taxfree when bond owners, their spouses, or their dependents pay for college tuition and fees. This is an income-based exclusion so the tax exclusion is phased out between $115,750 and $145,750 for taxpayers filing as married filing jointly and between $77,200 and $92,200 for single and married filing separate taxpayers.

A Coverdell Education Savings Account is a trust or custodial account set up solely for paying qualified educational expenses for the designated beneficiary of the account. When the account is established, the designated beneficiary must be under the age of 18 or have a special needs designation. The account must be designated as a Coverdell Education Savings Account when it is established, and the document creating and governing the account must be in writing and contain certain specific items.

The American Opportunity Credit is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student.

If the credit brings the amount of tax you owe to zero you can have 40 percent of the any remaining amount of the credit refunded to you. The amount of the credit is 100 percent of the first $2,000 of qualified education expenses you paid for each eligible student and 25 percent of the next $2,000 of qualified educational expenses you paid for the student. The credit is phased out for income between $160,000 and $180,000 for married taxpayers filing jointly and between $80,000 and $90,000 for taxpayers that choose other filing statuses.

There is also a Lifetime Learning Credit available that is available for students beyond their first four years of higher education. This credit is for $2,000 per year and there is no limit on the number of years you can claim the credit. Your income must be less than $131,000 for married filing jointly couples to claim the credit and less than $65,000 for taxpayers choosing the other filing statuses that are available.

Student loan interest can also be deducted as an above the line deduction as long as the debt was incurred to the pay the college costs for yourself, your spouse, or your dependent while enrolled as a student at least half-time in a degree program. This deduction is also subject to income limitations and phase outs.

These tax savings opportunities related to higher education by no means eliminate the insane costs associated with higher education. They do, however, help to reduce the pain a bit and help to make it a bit more affordable for these expenses.

Paul Pahoresky is a partner in the accounting firm of JLP CPAs. He can be reached at 440-974-1040x14 or at paul@jlpcpas.com. Consult your tax advisor for your specific situation for additional information and guidance on these topics.

Paul Pahoresky