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Tax Benefits for Education (Part 2)

 

Tax Benefits for Education (Part 2)

2013-2014 Federal Education Tax Breaks for College Savings Plans

Elizabeth Rosen
by Elizabeth Rosen, Contributor

This article is second in a series titled “Tax Benefits for Education.” Read the first article HERE: Tax Breaks for Tuition and Fees

The IRS offers a variety of education tax benefits that you may be able to take advantage of on your Federal tax return. This post provides a breakdown of the tax relief that is available for qualified college savings plans.

Your eligibility for Federal tax credits and tax deductions is based on your AGI and MAGI. Your AGI (adjusted gross income) is determined by taking your total annual income and reducing it by certain adjustments — such as student loan interest, IRA contributions, alimony payments, moving expenses, and ½ of any self-employment taxes paid. Your MAGI (modified adjusted gross income) is calculated by taking your AGI and adding back certain items —including student loan interest, IRA contributions, passive income or loss, and ½ of self-employment tax. Your AGI and MAGI also affect whether or not you can claim the maximum amount allowed for a particular tax benefit.

The term “tax deferred” (or “tax deferral) means that a taxpayer can delay owing taxes on a particular investment to a future period. This allows your investment earnings to experience tax-free growth until you make a withdrawal.

 

Qualified Tuition Programs (QTPs) or “529 Plans”

What It Is: A state-run program which allows someone to prepay, or contribute to an account set up to pay, for a student’s qualified education expenses at an eligible postsecondary institution.

Contribution Limits: There are no income restrictions for individual contributors. Contributions cannot be greater than the amount needed to pay the qualified education expenses for the designated beneficiary.

Qualified Education Expenses: Expenses which are related to enrollment or attendance at an eligible educational institution — including tuition and fees, books, supplies, and equipment. Expenses for room and board qualify for students who are enrolled at least half-time.

Tax Benefit: Distributions are tax-free (unless the amount is greater than the beneficiary’s adjusted qualified education expenses for the year). If you receive a taxable distribution, you will be subject to an additional 10% tax on the amount included in income.

NOTE: You can contribute to both a Qualified Tuition Program (QTP) and a Coverdell ESA during the same year for the same designated beneficiary.

 

Coverdell Education Savings Accounts (ESAs)

What It Is: A trust or custodial savings account designed to pay for the qualified education expenses of a designated beneficiary

How to Set It Up: You can open a Coverdell ESA at any bank or entity approved by the IRS.

Who Is Eligible: The beneficiary must be less than 18 years old, or a special needs beneficiary. Account must be used by the time the beneficiary is 30 years old (unless special needs).

Who Can Contribute: Any individual whose MAGI is below $110,000 (or $220,000 if married filing jointly), including the beneficiary

Annual Contribution Limit: $2,000 per designated beneficiary. Note that contributions must be in cash.

Qualified Education Expenses: Expenses that are required for enrollment or attendance at an eligible educational institution — including tuition and fees, books, supplies, and equipment. Can be either qualified higher education expenses or qualified elementary and secondary education expenses.

Tax Benefit: Earnings are tax-deferred, and distributions are tax-free (unless the amount is greater than the beneficiary’s adjusted qualified education expenses for the year). If you receive a taxable distribution, you will be subject to an additional 10% tax on the amount included in income.

NOTE: You can contribute to both a Qualified Tuition Program (QTP) and a Coverdell ESA during the same year for the same designated beneficiary.

 

Education Savings Bond Program

What It Is: The interest earned on U.S. savings bonds is usually taxable. However, certain qualified savings bonds (under the education savings bond program) may be cashed in with (some or all of) the interest being excluded from your income.

Qualified U.S. Savings Bonds: Series EE bonds issued after 1989, and any Series I bonds

Who Is Eligible: The owner must be at least 24 years old before the bond’s issue date. The bond must be issued in your name (if you’re the sole owner) or in the name of both you and your spouse (as co-owners).

Limits on MAGI: $89,700 if single or head of household; $142,050 if married filing jointly or qualifying widow(er) with dependent child

Qualified Education Expenses: You must be paying the qualified expenses for yourself, your spouse, or your dependent. Includes tuition and fees, but not room and board. Also includes rollover contributions to a qualified tuition program (QTP) or a Coverdell ESA.

Tax Benefit: Qualified U.S. savings bonds can be cashed in tax-free (unless the amount is more than the adjusted qualified education expenses for the year). The amount of interest that can be excluded from your income is based on your MAGI and filing status.

 

Conclusion

It’s important to note that most education tax benefits are intended for people who are single filers or married joint filers. Also keep in mind, the IRS will not permit you to claim different tax breaks for the same expenses (often called “double dipping”). Make sure you understand which benefits you actually qualify for and what combination of tax breaks works best for you. For more information, see IRS Publication 970 (Tax Benefits for Education).