Tax Tips
Economic Growth and Tax Relief Reconciliation Act of 2002 - Part III - February 2002
Richard Scrivanich - Partner
In this month's Tax Tips, we'll continue on with our analysis of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and specifically look at the changes made in the education area.
Education provisions.
Unlike other provisions that phase in over a number of years, the education provisions start providing relief in 2002. Both the Education IRA-now called Coverdell Education Savings Accounts-and the Section 529 Tuition Program are designed to encourage parents to save for their children's education. Changes in tax law are likely to make both of these investment vehicles more attractive.
Education IRAs.
If you previously disregarded education IRAs because you considered the $500 annual contribution limit too low to build any significant college savings, it's time to take another look. The new tax law, beginning next year, boosts the amount you can put into an Education IRA from the $500 in 2001 to $2,000. Contributions are not deductible, but earnings accumulate tax-free and distributions you make to pay qualifying educational expenses are available tax-free. For families with special needs children, EGTRRA allows for contributions to continue beyond age 18. And a new provision makes it possible for corporations and other entities to contribute to Education IRAs for the benefit of their employees.
Furthermore, EGTRRA substantially increased the contribution phase-out range for joint filers, so now more families with higher incomes can take advantage of this savings tool. Joint filers with adjusted gross incomes (AGIs) below $190,000-up from $150,000- make a full contribution. Those with income below $220,000 may be eligible for a partial contribution.
To make Education IRAs consistent with traditional IRAs, the deadline for contributing has been extended from December 31 to April 15 following the year for which the contribution is being made.
Finally, don't wait to set up an Education IRA-it can become a powerful tool for meeting future tuition obligations.
Elementary-level education.
The legislation also expands the types of expenses that qualify for tax-free distributions from Education IRAs. A new provision specifically permits distributions for elementary and secondary school expenses (including costs to attend private and religious schools), and expenses for academic tutoring, certain computer technology, uniforms, transportation, and extended-day programs.
Note:
If you plan on sending your child to college and don't need the funds to pay for these pre-college expenses, it would make more sense to retain the funds in the Education IRA so earnings can continue to compound tax-free for a longer time period.
Section 529 plans.
The plans usually take the form of prepaid tuition accounts or state-sponsored savings plans. Effective in 2002, qualifying higher education distributions from these programs will no longer be subject to tax. Previously, payouts were taxed at the student's rate. If you have money in a Section 529 Plan and can wait, it makes sense to hold off on withdrawing funds until next year when qualified distributions will be tax-free.
The new law opens the door for private colleges to offer prepaid tuition programs. The same tax-free provisions will apply to private college Section 529 Plans-but you'll need to wait until 2004 to make those distributions tax-free. Section 529 tuition programs are likely to appeal to higher income taxpayers because all taxpayers, regardless of income, can put money in a Section 529 Plan.
Also, effective in 2002, you can contribute to both an Education IRA and a Section 529 Plan in the same year for the same beneficiary.
College expenses.
For those of you who are already paying tuition or who will start within the next few years, EGTRRA introduces a brand new and much-needed break for people paying college expenses. In 2002 and 2003, eligible taxpayers can deduct up to $3,000 worth of qualifying expenses "above the line," which means you don't have to itemize deductions on your return to qualify for this tax break. The amount of the deduction will rise to $4,000 in 2004 and 2005, before it is scheduled to disappear. Eligibility is determined by your AGI, and is not available to married taxpayers filing separately.
Note:
As enacted, the deduction terminates and won't be available for tax years beginning after 2005. Although expiring provisions are often extended, it is impossible to predict. Therefore, unless you have children that are or will be in college in the next few years, you may not be able to take advantage of this new provision.
Rules to remember.
When it comes to selecting and coordinating education tax breaks, the rules can be confusing, but here are the ones you need to keep in mind:
- A tuition deduction cannot be claimed in the same year as a HOPE or Lifetime Learning Credit for the same student.
- You can take a tax-free withdrawal from a Section 529 Plan or an Education IRA in the same year you claim a Hope or Lifetime Learning Credit, as long as the funds are not used for the same educational expenses.
- Although qualifying distributions from a Section 529 Plan are tax-free after 2002, if this provision is not extended before the Act expires in 2011, withdrawals from a Section 529 Plan would again become taxable to the student who gets the benefits. Distributions from an Education IRA have never been taxable, so expiration of the law in 2011 would not change the tax exemption for withdrawals from those accounts.
Student loan interest.
At present, qualifying taxpayers, even those who don't itemize, can claim a deduction for up to $2,500 per year for interest paid on student loans during the first 60 months that interest payments are required. Although the deduction for student loan interest remains limited to $2,500 per year, under EGTRRA, eligibility to deduct student loan interest extends for the life of the loan. This should come as welcomed news, since many students repay student loans over a 10-year term.
In addition, the phase-out rule that limits or eliminates college-loan interest deductions for high income taxpayers has been liberalized. Income eligibility for the student loan interest deduction will increase from $50,000 to $65,000 for singles and from $100,000 to $130,000 for married couples filing jointly. The student loan interest provision takes effect beginning in 2002.
The changes made by the new tax law are extensive and may seem overwhelming. However, make every effort to take advantage of them, especially the reduced income tax rates and the increased contribution limits for retirement accounts. These two areas alone can make a big difference in your tax bill this year and next.
In the meantime, if you have any questions concerning the new tax act, please feel free to give me a call at (562) 698-9891.
Return to Tax Tips Archives
All rights reserved. For personal use only.
Do not duplicate or distribute without permission. All information in this
article is for informational purposes only.
Some of the articles included here were written in a prior
year or before a current tax law change. Therefore some of the information in
the older articles may not still be valid. Any dollar thresholds indicated
relate only to the year for which the article was written and could be different
for the current year. Please discuss with us your personal situation before
acting on any of the information provided. If you have any questions,
please give us a call at (562) 698-9891.
|
