There are actually a number of tax and investment
strategies you can use to help finance college expenses and the Relief and
Reconciliation Act has greatly enhanced this area. We'll
outline below some of the best options available.
American Opportunity Tax Credit
A tax credit of up to $2,500 per student is available for the
first four years of college education. Unlike the previous Hope Credit that it
replaced, 40% of the American Opportunity Tax Credit ($1,000) is
refundable even if no tax is due. The tax credit is 100% of the first
$2,000 of any tuition and
eligible class fees paid, and 25% of the second $2,000 in tuition and class fees paid (maximum of
$2,500). Athletic fees, housing costs, student activity fees,
transportation and isurance are not eligible
expenses for the Hope or Lifetime learning credits.
The credit starts to phase out for single taxpayers with adjusted
gross income above $80,000 and for others
filing a joint tax return, the adjusted gross income phase out starts at
Lifetime Learning Credit
A tax credit of up to $2,000 per student is available for any
college tuition paid during a year that the American Opportunity credit is not claimed. The credit is 20% of any
tuition or class fees paid up to $10,000 (for a total allowable credit of $2,000).
You cannot claim the credit if you are a dependent on someone else's
return or if your modified adjusted gross income exceeds $63,000 (or
$127,000 for a married filing joint return). The lifetime
learning credit has the same eligible expense limitations as the American
Financial aid planning for college is often more important than tax planning. Steps
can be taken to increase your child's chances of receiving grants or a subsidized Stafford loan by
decreasing the child's income and assets and if possible your income and assets. This should be
done the year before you apply for loans or grants.
Some specific financial-aid strategies are:
Series EE Savings Bonds
- shift investment assets from your child to you. The student's assets are a much bigger
factor in the financial aid formula than the parents assets
- move investment assets that produce interest and dividends into growth investments
- if you control an S corporation or C corporation, shift personal assets into the
corporation (please consult with us before doing this - you don't want to shift appreciated
assets into your corporation)
- if you control a C corporation, reduce your salary and keep the money in the
corporation until after your child leaves school
- have two or more family members attend college at the same time
If you own Series EE Savings Bonds, you may be able to redeem the bonds tax-free when you use
the money to pay for college tuition in the year of redemption. However, any tuition costs that are
used in the calculation of the American Opportunity or lifetime learning credits cannot be included in determining
whether the Series EE bond redemption is tax-free.
Coverdell Education Savings Account (Formerly Known As An Education IRA)
This program has been expanded tremendously in recent years. Coverdell
ESAs now cover not only the costs of
higher education, but also the costs of public and private
elementary and secondary education. The
annual contribution limit to an ESA is $2,000.
Contributions will also
be permitted all the way until the filing date of the return (April
15th of the following year) and the adjusted gross income ceiling
for allowable contributions is $110,000 (single return) or
$220,000 (on a married filing joint return).
Qualified Tuition Programs
You may want to use a qualified tuition program if your state offers one. A qualified tuition
program allows you to purchase future tuition in any of your state's colleges at today's prices.
The advantages are that you will avoid any "tuition inflation" which has historically been much
higher than regular inflation, your investment will grow tax-free until your child begins college,
and you will still be eligible for the Hope and lifetime learning credits.
However, if your child
doesn't go to college or decides to go to college in another state, you may just get back your
original investment without any of the accumulated earnings or with only partial earnings.
Depending on which state you live in, this can be one of the best college investment strategies.
Since the 2001 Tax Relief Act, private institutions of post-secondary
learning can sponsor qualified tuition programs
whereby taxpayers may pre-pay tuition costs. Distributions from qualified
tuition programs are excludable from gross income.
You are entitled to a
deduction for qualified tuition costs of up to $4,000 provided your
adjusted gross income is below $80,000 ($160,000 joint). The college tuition deduction cannot be claimed
in the same year as an American Opportunity or Lifetime Learning credit for the same
Gifting Appreciated Investments
If you have appreciated investments, you may want to give them to your child to sell and use
for college. If you sell appreciated stock to finance your child's education,
you will likely pay either a 15% or 20% capital gains tax. However,
if you gift the stock to your child, he or she could possibly pay a much
lower or even no tax on the same sale. If your child is going to qualify for financial aid
however, giving them investments may
disqualify them from receiving the financial aid.