Tax Tips
How the Nontraditional Back-to-School Crowd Pays for Its Education - June 2006
Richard Scrivanich - Partner
Did you know that upwards of 43% of college students are deemed “nontraditional”? Loosely interpreted, “nontraditional” refers to those students who are not 18 to 22, who work or have worked, who may be far along in their careers, or who may have served in the military and then attended school.
If you’ve decided to go back to school to finish your college degree, earn a second or third one, or pursue graduate or professional level education, then it’s high time you brush up on your tax savings knowledge as it relates to higher education. Careful planning can yield considerable savings on the ever-inflating cost of higher education.
The Hope Tax Credit
The Hope Tax Credit is a credit against your federal income tax liability. You may claim a tax credit up to $1,500 for only two tax years, and it only applies to the first two years of postsecondary education.
The Hope Tax Credit is available only to single taxpayers with modified adjusted gross income (MAGI) of less than $52,000 or married taxpayers, filing jointly, with MAGI less than $105,000. The maximum credit amount of $1,500 is gradually reduced for incomes between $42,000 and $52,000 if single, or $85,000 and $105,000 if married. The credit is not available to married taxpayers who file separately. To obtain this benefit, you must be enrolled at least half-time in an eligible program leading to a degree or certificate during the calendar year.
Our office will calculate the actual amount of the Hope Credit available based on your household income, your number of dependents, the amount of qualified tuition and fees paid, and the amount of certain scholarships and allowances subtracted from tuition.
The Lifetime Learning Tax Credit
Closely analogous to the Hope Credit, the Lifetime Learning Tax Credit provides a credit against your federal income tax liability. Key differences between the two include the number of years this credit is available and the maximum amount of the credit.
The Lifetime Learning Tax Credit provides for a credit of 20% of the first $10,000 of qualified educational expenses, resulting in a maximum credit of $2,000 for each year you are pursuing postsecondary education or taking courses to acquire or improve your job skills. There is no limit on the number of years you can claim this credit.
Our office will perform if detailed analysis to determine the exact amount of this credit for which you are eligible.
Interest deduction
Student loan interest deduction: Federal aid is not age-restrictive, so you can always opt to apply for educational loans. The maximum deduction is $2,500, and you don’t need to itemize to claim this deduction.
To qualify, you must meet two requirements:
First, the student loan on which you’re paying interest must be one that you incurred to pay college expenses when you were at least a half-time student. This requirement excludes part-time adult learners or other nontraditional students.
Second, you must meet income limits. To take the full student loan interest deduction, single filers must have a modified adjusted gross income (MAGI) below $50,000 (below $100,000 for married persons filing jointly). A partial deduction is available for single filers with an MAGI between $50,000 and $65,000 (between $100,000 and $130,000 for married filing jointly). These income limits are adjusted annually for inflation.
Early each year, a lender must send Form 1098-E to any borrowers who paid that lender over $600 of interest on a qualified student loan the previous year. The form provides details on the amount of interest you paid–contact your lender in the event the form is not sent to you.
Home equity line of credit: Some returning students prefer to take advantage of the low interest rates typically associated with home equity lines of credit. If you choose this route to pay your tuition, you can deduct the home equity loan interest. This is a particularly attractive option for nontraditional students with high incomes, as there are fewer income limits to worry about when claiming this deduction, like with deductions for student loan interest. Certain limitations associated with home equity lines of credit exist, even when used for tuition. For example, you can only deduct up to $100,000 of indebtedness, and there is a separate set of AMT rules that can come into play.
Employer Tuition Reimbursement Programs
Some of you have the good fortune of working for an employer with a tuition reimbursement program. The law allows working adults to receive up to $5,250 per year tax-free for tuition and fees associated with graduate and undergraduate level courses. The classes do not need to be job-related. Consult your employee handbook and our office for more information on this benefit.
Early withdrawals from IRAs
Traditional IRA: The 10% penalty tax imposed on IRA withdrawals before age 59 ½ does not apply if the distribution is used to pay for “qualified” higher education expenses. You must pay regular income tax, however, on these early withdrawals. Call our office to determine which expenses are deemed to be “qualified.”
Roth IRAs: You can avoid the early withdrawal 10% penalty tax if the distribution is used to pay for your qualified higher education expenses, but be advised that you will owe income tax on any earnings withdrawn from the account. The good news–withdrawals from a Roth are treated as being taken from contributions first, which are not subject to tax. To the extent you have met the Roth withdrawal rules (age 59½ and contributions made at least fives years before), your distributions will be completely tax-free.
Other alternatives
Another tool–if you know that you will go back to school several years in advance of commencing your studies–is to set up your own 529 plan to save for educational expenses. This attractive option is not limited to savings for the educational needs of your children and grandchildren, contrary to popular belief. Our CPAs can talk to you about the particulars of this tax-free savings vehicle.
Saving what is possibly the best idea for last, free money is always the preferred way to go. If you are over 60 years of age, don’t forget to investigate the over-60 programs at schools, many of which offer free or low-cost tuition incentives to promote lifetime learning and campus diversity.
If you have any questions regarding education tax matters or any other tax matter, please feel free to give me a call at (562) 698-9891.
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