Education Credits & 529 Plans

They say only two things are certain in life–death and taxes.  Another certainty is creeping in and that is education costs will continue to rise significantly and jobs that used to require a bachelors degree now require a masters degree.  Thankfully, income tax credits are available to help defray some costs and since 1996 529 plans can help you fund education costs and both are outlined below as well as ways to use them in conjunction with one another.

Tax Credits

American Opportunity Tax Credit

The American Opportunity Credit originally modifying the Hope credit for tax years 2009 & 2010 was then extended for 2011 & 2012 and with the recent fiscal cliff deal, extended further to tax years 2013-2017.  The credit can be claimed for an undergraduate student for  four years with a potential tax subsidy of $10,000 over the four year period. Now the fine print.

  • The full credit is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above these levels.
  • The amount of the credit is calculated as 100% of the first $2,000 in qualified tuition and fees costs paid, plus 25% of the next $2,000 paid for such fees for a maximum of $2,500.  Up to 40% of the credit ($1,000) can be refundable meaning even if you owe no taxes you still receive some benefit.
  • Qualifying fees includes expenses for course-related books, supplies, and equipment that are not necessarily paid to the educational institution.  Qualifying fees do NOT include room and board, transportation, insurance, medical expenses, student fees unless required as a condition of enrollment or attendance, same expenses paid with tax-free educational assistance (we’ll talk about this below), same expenses used for any other tax deduction, credit or educational benefit (scholarships, grants, etc).
  • Eligible student criteria–(1) is enrolled in a program leading toward a degree, certificate or other recognized post-secondary educational credential; (2) has not completed the first four years of post-secondary education as of the beginning of the taxable year; (3) for at least one academic period is carrying at least ½ of the normal full-time work load for the course of study the student is pursuing; and (4) has not been convicted of a felony drug offense.

Lifetime Learning Credit

The Lifetime learning credit is a nonrefundable credit of 20% of qualified tuition and fees up to $2,000 per return for any student, regardless if they are full-time or pursuing a degree and can be used an unlimited number of years.

  • The full credit is available to those with a modified adjusted income of less than $124,000 for married filing joint.
  • For purposes of the lifetime learning credit, qualified education expenses are tuition and certain related expenses required for enrollment in a course at an eligible educational institution. The course must be either part of a post-secondary degree program or taken by the student to acquire or improve job skills.

529 Plans

A great way to save for your child’s college education is with 529 plans.  They come in all different shapes and sizes and even though contributions are not deductible for federal tax purposes some states, including Colorado, provide an income tax deduction for contributions.  Distributions from a 529 plan can be used tax free for the following:

  • Tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.
  • Room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.
  • Qualified education expenses do not include student loans and student loan interest.

Using Tax Credits and 529 plans to your Advantage

Utilizing both the tax credits available and tax-free earnings from 529 properly can save money when faced with college expenses.  If you don’t exceed the income cap for the American Opportunity Credit (AOTC), it’s best to utilize the $2,000 of dollar for dollar money back in your pocket.  You cannot “double dip” and use the same expenses for the AOTC as you do for tax-free distributions from a 529 plan. Easiest scenario is to use $2,000 out of pocket to cover tuition which you’ll get back in taxes and use the 529 distribution money for everything else, including room and board.  If you are looking at last year’s taxes and realize you want to take the credit but all costs were covered by 529 money, you can still take the credit but will have to claim a portion of the earnings from the 529 distribution.  A great tutorial on this is found here on the IRS website.

Good luck with educating yourself and the next generation at higher institutions of learning and as always, if you have questions regarding the tax laws, please contact a tax professional.

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