Whether you've been saving for years or supporting a student loan, now is a great time to look at some ways may be able to save more on your taxes as you help pay for college. Here are five tips that you might consider: (Please keep in mind that this information is not tax advice and should not be relied on as tax or legal advice as it may not apply to everybody. Be sure to consult a tax advisor to see if these options are right for you.)
Tip # 1: The American Opportunity Tax Credit
If you are currently funding a child's college education, the American Opportunity Tax Credit may bring some instant tax relief. Available only for the years 2009 and 2010 (unless Congress decides to extend it), the tax credit is for undergraduate college education expenses and may provide up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses.
If your modified adjusted gross income is below $80,000 per year (or $160,000 per year for joint filers), you may be eligible for the full credit of $2500. And if your gross annual income is more than those amounts, you may still have the option to choose not to claim your child as a dependant on your taxes. By filing his or her federal tax return independently, your child may be eligible to claim the tax credit (as long as the student's gross income is less than $80,000).
For example: Ken chooses not to claim his daughter, Linda as a dependent on his tax return. Under IRS regulations, Linda could claim the American Opportunity tax credit on her federal income tax return if she qualifies. By doing so, Ken cannot claim any education tax credit.
Tip # 2: Student Loan Interest Deduction
Students and parents both fret about the high cost of student loans. But there's a bright side! Depending on your total income, you may be able to deduct up to $2,500 worth of student loan interest from your taxable income—even if the loans aren't government-subsidized!
If you're filing individually, you may get the full benefit if your taxable income is below $60,000. It is phased out for incomes up to $75,000 per year. If you're married and filing jointly, you may get the full benefit if your total income is less than $120,000 per year, and it phases out for incomes up to $150,000 per year.
It might sound like there's a lot of paperwork involved, but you don't have to trace the loan payments back to your tuition. For example, if you borrowed money over the summer in order to pay for school, spent the money, and then paid your tuition through a monthly payment program, you still may qualify for a tax deduction.
Tip # 3: Penalty-free IRA Withdrawals
You may make penalty-free withdrawals from regular IRAs to pay for undergraduate or graduate expenses (qualified expenses) for yourself or other members of the family—including the spouse, children, grandchildren, spouse's children, or spouse's grandchildren—at an eligible educational institution. The taxpayer will owe federal income tax on the amount withdrawn, but may not be subject to the 10% early withdrawal penalty (imposed when amounts are withdrawn from an IRA before the taxpayer reaches age 59½).
Tip # 4: U.S. Series EE Bond Tax-free Interest
The interest from EE Bond redemptions, used to pay for qualified education expenses, is generally tax-free. The tax-free interest is phased out when the taxpayer reaches certain levels of Modified Adjusted Gross Income. It is phased out when the Modified Adjusted Gross Income (2009 amounts) is between $69,950 to $84,950 for single or head of household taxpayers and between $104,900 to $134,900 for married taxpayers. These levels are adjusted yearly for inflation.
Parents who have acquired series EE bonds intending to use them tax-free for qualified education expenses may find that their income level may be over the amount to achieve tax-free redemptions. In this scenario they can rollover the bonds to a Qualified Tuition Plan such as a 529 Plan. The parents may also benefit from a state tax deduction for Qualified Tuition Plan contributions for the rollover.
Tip # 5: Qualified Higher Education Expense Deduction
An individual may be permitted to claim a tax deduction for qualified tuition and related expenses paid during the year 2009. This includes expenses such as tuition and mandatory enrollment fees to attend any accredited public or private institution above the high school level. However, costs associated with room and board, student activities, transportation, and other expenses are not permitted.
Also, remember that you cannot claim both the deduction for tuition and fees and an education credit such as the Lifetime Learning Credit or the Hope Credit for the same student in the same year.
Deduction and Adjusted Gross Income limits:
Modified Adjusted Gross Income Limits Maximum
NOTE: The tuition deduction is scheduled to expire at the end of 2009, but may be extended through 2010.
The information provided is for informational purposes only and should not be relied on as tax or legal advice. Please discuss you particular situation with your tax advisor.
Investments in 529 college savings plans are neither FDIC neither insured nor guaranteed and may lose value. Please review the plan's disclosure document for details such as investment objectives, risks, charges and expenses, and other information that you should read and consider carefully before investing. Plan disclosure documents can be obtained directly from the plan. Investors should consider before investing whether their or their designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program and should consult their tax advisor.