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For each year beginning in 1998, you may be able to contribute up to $500 to an education IRA for a child under age 18. An education IRA is a trust or custodial account created only for the purpose of paying the qualified higher education expenses of the designated beneficiary of the account. Any individual, including the child, can contribute to a child's education IRA. The $500 maximum contribution for each child is gradually reduced when modified adjusted gross income is between $95,000 and $110,000 for individuals and $150,000 and $160,000 for married filing jointly. There is no limit on the number of education IRAs that can be set up for a child; however, total contributions for that child cannot exceed $500 per year. Although there is no up-front deduction, the amounts deposited in the accounts grow tax free and distributions from the accounts are also tax free to the extent the amounts distributed are used to pay qualified higher education expenses of the education IRA beneficiary. Qualified higher education expenses include tuition, fees, books, supplies and equipment. They also include amounts contributed to a qualified state tuition program and room and board if the designated beneficiary is at least a half-time student at an eligible educational institution.
Note: The HOPE credit and lifetime learning credit cannot be claimed for a student's qualified higher education expenses in the same year in which the student receives a tax-free withdrawal from an education IRA. The student may waive the tax free treatment of the education IRA distribution in order to claim the HOPE credit or lifetime learning credit. Also, no contributions can be made to an education IRA on behalf of a child if any amount is contributed during the tax year to a qualified state tuition program on behalf of the same child. The contribution limits to other types of IRAs ($2,000 per year) are not affected by contributions to education IRAs and limitations on contributions to education IRAs are not tied to compensation amounts. If the education IRA funds are not used up paying college expenses, any remaining balance has to be distributed by the time the beneficiary turns 30; however, unused amounts may be rolled over into an education IRA for another family member. Any distribution not used for qualifying expenses is subject to both the ordinary income tax and a 10% penalty tax on the portion considered earnings.
Pointer:It makes good sense to contribute to an education IRA wether or not the amounts will be used for the child's education. The amounts contributed accrue tax free, and can be withdrawn at a later date. If the amounts are not used for the child's education, payment of the small penalty and tax at this later date is a small price to pay for years of untaxed accumulation. As long as you do not use the amounts in the educational IRA for education, the Hope and Lifetime Learning Credits are still available for the parent to use in the child's behalf.
Code Sections 25A, added to the taxpayer Relief Act of 1997 allows taxpayers to claim two types of non-refundable credits for qualified educational expenses: the Hope Scholarship Credit and the Lifetime Learning Credit. Both credits are available for the educational expenses of the taxpayer, the taxpayer's spouse, and the taxpayer's dependents.
Phaseout of Credits - Both credits are phased out ratably for taxpayers with modified adjusted gross income (AGI) beginning at $40,000 and completely phased out at $50,000 for a taxpayer filing a single return and head of household. A jointly filed return has a phaseout beginning at $80,000 and the credit is completely phased out at $100,000 of AGI. Taxpayers filing married filing separate are not eligible for the Hope Scholarship and Lifetime Learning Credits.
Election of Credits - The election of credits is made by attaching Form 8863, Education Credits to a timely filed (including extensions) tax return for the year the credit is claimed or to an amended return filed before the expiration of the limitations period for filing a claim for credit or refund. (Notice 99-32).
Qualified Expenses - The credits may only be claimed for qualified tuition and related expenses. Qualified expenses consist of tuition and fees required for enrollment or attendance at an eligible educational institution for courses of instruction at the institution. (IRC 25A(f)(1)(A). The test for determining whether any fee is a qualified tuition and related expense is: Is the fee required to be paid to the eligible education institution as a condition of the student's enrollment or attendance at the institution? Fees for books, supplies, and equipment used in a course of study only qualify if the fee must be paid to the eligible educational institution.
In determining the amount of an education credit, qualified tuition and related expenses paid during the year are reduced by the following amounts paid to, or on behalf of, a student:
A grant or scholarship will not reduce qualified expenses if the student reports it as income or its terms require that it be applied to expenses other than qualified tuition and related expenses (room and board).
Third Party Payments - If someone other than the taxpayer, spouse, or a claimed dependent pays qualifying expenses for a student, these are treated as paid by the student. However, if the student is your dependent, you (not the student) take the credit, if eligible.
Recapture of Prior Credits - Similar to all tax benefit rules, if, in a taxable year a taxpayer receives a refund of qualified tuition and related expenses for which the taxpayer claimed an educational credit in a prior taxable year, the tax for the subsequent taxable year is increased by the recapture amount. The recapture amount is the difference between the credit claimed in the prior taxable year and the predetermined credit.
The Hope Scholarship Credit provides a credit of up to $1,500. The credit is available for the first $1,000 in qualified tuition and related expenses for an eligible student and for 50 percent of the next $1,000 in qualified expenses. Code Section 25A(b)(1). The credit allows $1,500 per eligible student, not per return. These amounts are indexed for inflation for tax years beginning after 2001. Code Section 25A(h)(1).
The Hope Scholarship Credit is allowed only for two taxable years per student. It is allowed only for the first two years of post-secondary education at an eligible educational institution. The credit is not available for the expenses of graduate education or of undergraduate education beyond the first two years, but in theory could meet the entire tuition costs of a community college program.
Example: Prior to 1999, Barbara attended college for several years on a full-time basis. Barbara transfers to College X for the 1999 Spring semester. College X awards Barbara credit for some (but not all) of the courses she previously completed, and College X classifies Barbara as a first-semester sophomore. During both the Spring and Fall semesters of 1999, Barbara enrolls in half the normal full-time work load for this degree program. Because College X does not classify Barbara as having completed the first two years of post-secondary education as of the beginning of 1999, Barbara is an eligible student for taxable year 1999.
The Hope Scholarship Credit is not allowed for a student who has been convicted of a federal or state felony drug offense.
An individual must be at least a half-time student for at least one academic period of the year to be an eligible student for purposes of the Hope Credit. To be an eligible student the individual must also meet the requirements of the Higher Education Act of 1965. The Higher Education Act requires that a student be enrolled or accepted for enrollment in a degree, certificate, or other program leading to a recognized educational credential at an eligible institution of higher learning and not be enrolled in an elementary or secondary school.
Observation: Because this provision excludes a student enrolled in a secondary school from the definition of an eligible student, it appears that the credit is not available for the expenses of a high school student taking courses at a college or university. The proposed regulations provide the following example involving a high school student but infer that the student is ineligible because he is not enrolled in a degree program.
Example: During the 1999 Fall semester, Don is a high school student who takes classes on a half-time basis at College X. Don is not enrolled as part of a degree program at College X because College X does not admit students to a degree program unless the student has a high school diploma or equivalent. Because Don is not enrolled in a degree program at College X during 1999, Don is not an eligible student for taxable year 1999. Prop. Reg. Section 1.25A-3(d)(2), Ex. 5.
The Lifetime Learning Credit is available for an amount equal to 20 percent of so much of the qualified tuition and related expenses paid during the year as do not exceed $5,000 ($10,000 for taxable years beginning after 2002). Code Section 25A(c)(1). This allows a total credit of $1,000 per year for years before 2003 and $2,000 per year thereafter.
The Lifetime Learning Credit amount is calculated on a per family rather than a per student basis. Although a taxpayer may claim the credit for more than one family member, the amount of the credit does not change. Thus, a taxpayer who pays $5,000 in qualified expenses for himself and $5,000 in qualified expenses for a dependent may claim only a $1,000 credit.
There is no limit on the number of years the lifetime learning credit may be claimed for an individual. A taxpayer who continues to pay qualified expenses for herself or a dependent may continue to claim the credit for the relevant amount of the expenses.
The Lifetime Learning Credit is available for qualified expenses relating to any course of instruction at an eligible educational institution to acquire or improve job skills. Code Section 25A(c)(2)(B). A student may take as little as one course, as opposed to the requirement of the Hope Scholarship Credit that an individual be at least a half-time student. However, the Lifetime Learning Credit is not available for all educational expenses. The expenses still must be incurred in education related to acquiring or improving job skills so that a taxpayer who is in school only for entertainment purposes cannot claim the credit.
A taxpayer cannot take both the Hope and Lifetime Learning Credits with respect to the qualified expenses of one eligible student. If educational expenses are qualified under both credits, they are allocated to the Hope Credit. Code Section 25A(c)(2)(A). These expenses are then not taken into account in determining whether the taxpayer may claim the Lifetime Learning Credit. A taxpayer who claims the Hope Credit for paying the expenses of one eligible student may still claim the Lifetime Learning Credit if she pays the qualified expenses of another eligible student.
No double benefits are allowed. Neither credit is allowed for any expense for which a deduction is allowed under any provision of this chapter.
Education U.S. Savings Bonds
The exclusion of interest may be computed using the following formula:
Qualified Higher Education
Expenses Paid with Proceeds x Interest Received from
Total Proceeds Received from U.S. Savings Bonds
U.S. Savings Bonds
The exclusion is phased out at modified adjusted gross incomes from $50,850 to $65,850 for singles, $76,250 to $106,250 on joint returns. It is not available to taxpayers who are married filing separate. When claiming the interest exclusion you should keep a written record of the Series EE U.S. Savings Bonds issued after 1989 that you redeem. The written record should include serial number, issue date, face value and redemption proceeds of each bond. Form 8818 can be used as a written record. Documentation of paid qualified higher expenses during the year should also be kept.
|Education IRA||$150,000-$160,000||$95,000-$110,000||tuition, fees, books, supplies,
room and board if half-time student
|$500 contribution||any college, university, vocational school or other post secondary educational institution eligible to participate in the student aid programs administered by the Department of Education|
|HOPE Credit||$80,000-$100,000||$40,000-$50,000||tuition only||$1,500 credit||any accredited public, nonprofit, or proprietary postsecondary institution eligible to participate in student aid programs administered by the Department of Education|
|$80,000-$100,000||$40,000-$50,000||tuition only||$1,000 credit||any accredited public, nonprofit, or proprietary postsecondary institution eligible to participate in student aid programs administered by the Department of Education|
|Student Loan Interest Deduction||$60,000-$75,000||$40,000-$55,000||tuition, fees, books, supplies, equipment, room & board||$1,000 deduction||college, university, vocational school or other postsecondary educational institution eligible to participate in Department of Education Student Aid Programs or an institution conducting an internship or residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers post graduate training|
|U.S. Savings Bond Interest||$50,850-$65,850||$76,250-$106,250||•tuition & fees
•contributions to qualified state
•contributions to educational
|up to amount of qualified higher education expenses paid during redemption year||college, university, or vocational school eligible for federal funding|