College education is a huge expense. Parents should look into the various tax benefits that can help reduce the costs of sending a child to college. Here are some areas worth further investigation.
Section 529 College Savings Plans
Section 529 college savings plans are specifically designed for educational saving. You can invest a little at a time or contribute a larger lump sum, whatever approach works best for you. You choose how you want your contributions invested; your plan investments are then professionally managed. These plans offer several appealing features:
- Investment earnings accumulate tax deferred and won’t be subject to federal income taxes when withdrawn for your child’s qualifying educational expenses. (Excess withdrawals are subject to tax and a potential 10% penalty.)
- Some states offer their residents tax incentives for investing in an in-state plan.
- As a parent, you retain control of the money in the account even after the child turns 18.
- If your child does not attend college or deplete the fund, you can change the account beneficiary to another qualifying family member without losing tax benefits.
Coverdell Education Savings Accounts
Annual contributions to Coverdell accounts are limited to $2,000 per child. This maximum phases out (is gradually reduced to zero) for taxpayers with modified adjusted gross income (AGI) between $95,000 and $110,000 (between $190,000 and $220,000 for joint filers).
Your contributions accumulate tax deferred at the federal level and earnings are tax-free when used for qualified educational expenses such as tuition, room and board, and books. If you make withdrawals from the account for non-educational expenses, the earnings portion of the withdrawal may be subject to federal income tax and an additional 10% penalty.
Tuition Tax Credits
A tax credit gives you a dollar-for-dollar reduction against the taxes you owe the IRS. The following two education tax credits can help eligible parents alleviate the costs of educating a child.
- American Opportunity Tax Credit (AOTC)
This credit is worth up to $2,500 per year for each eligible student in your family. It’s for the payment of tuition, required enrollment fees, and course materials for the first four years of post-secondary education. The credit is allowed for 100% of the first $2,000 of qualifying expenses, plus 25% of the next $2,000 The available credit is phased out for single taxpayers with modified AGI between $80,000 and $90,000, and for married couples with modified AGI between $160,000 and $180,000.
- Lifetime Learning Credit (LLC)
This credit can be as much as $2,000 a year (per tax return) for the payment of tuition and required enrollment fees at an eligible educational institution. It is calculated as 20% of the first $10,000 of expenses. You cannot claim the credit for a student if you are claiming the AOTC for the student that year. Unlike the AOTC, qualified expenses for the LLC do not include academic supplies and no portion of the credit is refundable. The LLC is phased out (in 2020) for single taxpayers with modified AGI between $59,000 and $69,000, and for married couples with modified AGI between $118,000 and $138,000.
Student Loan Interest Deduction
A tax deduction lowers your tax liability by reducing the amount of income on which you pay tax. You can deduct interest on qualified loans that you take out to pay for your child’s post-secondary education. The maximum deduction is $2,500 per year, but it phases out for taxpayers who are married filing jointly with AGI between $140,000 and $170,000 (between $70,000 and $85,000 for single filers). The deduction is available even if you do not itemize deductions on your return.
The earlier parents start saving for college, the better. If you have questions about the various college savings tax benefits, please contact one of our tax accountants at Urbach & Avraham, CPAs.