Financing College Expenses        

Now that your kids are being hustled back to school and your finances are taking a major blow with education expenses, we thought it might be a good time to bring up a timely subject - financing your children's college tuition. 


As your tax and financial advisors, we're often faced with the unrewarding task of being the bearer of discouraging financial news, but we always try to soften the blows somewhat with good, sound strategies that can help you prepare as best you can.

There are actually a number of tax and investment strategies you can use to help finance college expenses


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 $160,000.

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 Opportunity credit.

Financial Aid

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:

  • 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
Series EE Savings Bonds

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.

Tuition Deduction

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 student..

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.