Don't Mess With Taxes

Originally posted as blog item on March 13, 2019. That post was updated Sept. 4, 2020.

College and its ever-increasing costs certainly have gotten a lot of attention.

There's the group of Democrats seeking their party's 2020 presidential nomination. Obviously spurred by the enthusiastic supporters of Independent-turned-temporary-Democrat Sen. Bernie Sanders and his promise of free college, many other White House wannabes also are talking up educational assistance.

Then there's this week's Operation Varsity Blues. You might not have caught the name, but let me drop two others to spur recognition: Felicity Huffman and Lori Loughlin.

Yeah, that's the name federal investigators gave to their take down of a far-reaching college admissions scheme.

Wealthy parents, elite school admissions issues: Actors Huffman and Loughlin are among the wealthy parents — and latest reports say many, many more are involved than the 50 cited in the original indictment — accused of being part of a conspiracy to get their children into elite schools by, among other things, allegedly bribing university personnel, contributing to a fraudulent scholastic charity and claiming tax deductions for the donations and faking student athlete resumes.

Those of us who, along with our families, worked hard and scraped together all the cash we could through various legitimate means to go to college can take some schadenfreude solace in these wealthy alleged college entry cheaters being caught.

But we can't gloat for long.

Well, I can. I'm done with my schooling.

But if you or your parents are paying for upcoming higher education semesters, you need to start looking at legal ways to make your college days possible. Uncle Sam can help.

There are many educational tax incentives, from tax credits and deductions to tax-favored savings options and scholarships and even employer help, that are available to students and their families.

It takes a little homework to find the educational tax benefits that meet your particular needs, but it could be worth it. Here's an overview.

Tax credits: Tax credits are the best tax break. Rather than simply reduce the amount of your income that's subject to tax, credits cut any tax you owe dollar-for-dollar.

There are two educational tax credits, the American Opportunity Credit and the Lifetime Learning Credit.

The American Opportunity tax credit provides up to $2,500 for each eligible student. It covers an eligible student's qualified education expenses paid during the student's first four years of higher education.

Like most tax breaks, it takes some calculating to get the most from the American Opportunity credit. You get a credit of 100 percent of the first $2,000 of qualified education expenses per student and then 25 percent of the next $2,000 in college costs.

But one of the best things about the American Opportunity credit is that it is refundable. That means, as that descriptor indicates, if the credit reduces your tax liability to zero, the excess is refunded to you. In the case of the American Opportunity credit, you can collect 40 percent of any remaining credit amount (up to $1,000) as a tax refund.

There are, of course, requirements that must be met, such as being a qualified student. Those specifics can be found at the Internal Revenue Service's special Web page on the American Opportunity tax credit.

Those details also include the income limits on just who can claim the full credit. To get the most benefit, your modified adjusted gross income (MAGI) must be less than $80,000 if you're a single filer or double that for married couples filing a joint return. taxpayers ($160,000 married filing jointly). And if your MAGI is more than $90,000 as a single taxpayer or $180,000 and you're married filing jointly, you can't claim the American Opportunity tax credit.

The Lifetime Learning Credit is for older students. It provides a maximum annual amount up to $2,000 per tax return. That amount is based on 20 percent of the first $10,000 of qualifying educational expenses.

The good thing about the Lifetime Learning Credit is that students who go beyond four years of studies and even workers taking career-improving classes can claim it. The bad news is that it is not refundable. If you have any excess Lifetime Learning Credit after it erases your tax bill, you lose that excess credit.

The Lifetime Learning Credit also has MAGI limitations. For the 2018 tax year, this credit phases out your income level is between $57,000 and $67,000; for married filing jointly couples, the limits are between $114,000 and $134,000. Once you make more that those amounts, you can't claim the Lifetime Learning Credit.

Again, you can find specifics on the Lifetime Learning Credit at the IRS' special online page.

Tax deductions: The hubby's perennial tax season chant is "deduct, deduct, deduct." Although not as immediately beneficial as a tax credit, deductions still can help. They help lower your taxable income level, which means you should have a smaller tax bill, possibly even falling into a lower tax bracket.

There are two current education tax deductions. Both are what are known as above-the-line deductions, meaning you don't have to itemize to claim them.

Both are available for qualifying undergraduate and graduate student costs. However, one of those educational deductions is on hold.

First, let's look at the deduction that's available now, the student loan interest deduction.

Many students and their families find that they need outside money to cover at least some college costs. When you take out a student loan, up to $2,500 of interest paid during the year can be claimed.

The student loan interest deduction also is phased out as student/family income increases. The limiting starts when MAGI is between $65,000 and $80,000 for single filers and between $135,000 and $165,000 for married filing jointly. And again, once you make more that those amounts, you can't deduct the interest.

The other above-the-line tax education-related tax deduction is the one for qualifying college tuition and fees. This provides up to $4,000 for just what the name says.

The tuition and fees deduction, however, also is part of a group of temporary tax breaks known as extenders which must be periodically renewed by Congress. That hasn't happened yet for the collection that expired at the end of tax years 2017 and 2018.

Conventional wisdom is that the extenders will, for the most part, be renewed. The timing of that legislative action, though, is unclear. It might or might not happen by this year's April filing deadline(s).

Education savings options: Americans aren't very good at saving. However, many parents do try to put away cash for their kids' eventual college costs. There are some tax-favored savings vehicles for these moms and dads (and grandparents and aunts and uncles, too).

The most popular are 529 plans, which get their name from the federal tax code section under which they were created. A 529 plan can be established for a youngster, known as the account beneficiary, and money contributed to it grows tax-free.

When the young person heads off to college, the 529 money can be used, again tax-free, to pay for qualifying education expenses, such as tuition, fees, books, supplies, equipment and room and board at eligible institutions.

While 529 plans were authorized by federal legislation, the plans themselves are administered by states. All 50 offer some type of 529 and you can invest in a plan established in another state if it better fits your family and educational needs.

Anyone can contribute to a student's 529 without worrying about income limits. But these donors don't get any tax benefit for their gifts. And speaking of gifts, a 529 plan is a good destination for the $15,000 annual gift exclusion amount.

And while there are no annual contribution limits for 529 plans, there are lifetime contribution limits. These vary by plan, with most recent limits ranging from ranging from $235,000 to $529,000.  

But federal law does say that 529 plan balances cannot exceed the expected cost of the beneficiary's qualified higher education expenses. Basically, this is what the states administering the plans believe will be the full cost of attending an expensive school and graduate school, including textbooks and room and board.

My earlier post 529 college saving plan perks and pitfalls has more on these plans.

Coverdell Education Savings Accounts also offer tax benefits when it comes to school costs, both higher education and pre-college expenses. The amount that can be contributed to a Coverdell, however, is much lower — at most $2,000 a year — and income limits — $110,000 ($220,000 for married filing jointly — apply to contributors.

Additional tax-free educational assistance: The tax code also allows for other, tax-free ways to cover many educational costs. This generally involves getting individuals income that is excluded from taxation.

A common way this is accomplished is by getting help from your boss. Such employer-provided educational assistance is offered by many companies to help their workers. As long as these programs are set up under IRS rules, you could get up to $5,250 for school costs without that money counting as taxable income to you.

Other companies also are looking at workplace benefits that help employees pay off their student debt. Last August, the IRS issued a private letter ruling that allowed a company to tie its workplace 401(k) contributions to workers' student loan repayments.

Some companies had established similar student loan workplace assistance arrangements even before the IRS announced its tax-favored position on that particular case and more could follow.

Then there are scholarships. We're talking actual, student qualifying assistance, not the kind of paid-for but fake assistance for faux athletes alleged in the Varsity Blues case.

As long as you meet IRS guidelines, the scholarship amount is tax-free. This generally means a student must be a candidate for a degree at an eligible educational institution and use the scholarship to pay qualified education expenses (e.g., tuition, enrollment fees, books, supplies and equipment required for the courses).

Support other students: Finally, speaking of scholarships, if you have some extra cash and want to help others get a quality education, you can create a scholarship at your alma mater.

Not to toot our own horns, but that's what the hubby and I did for students who need some help to begin and/or continue their journalism studies at Texas Tech University. We're proud of our school and how well it prepared us for our post-graduation professional lives. We want others to have similar opportunities.

Plus, it was fun and we met there, although we didn't start dating until later. But I (happily) digress.

Your school's financial services office, like the folks at TTU and its College of Media & Communication, will help you establish a scholarship program that meets your goals, student needs and Internal Revenue Service guidelines.

And unlike the alleged fraudulent contributions that some charged in Operation Varsity Blues are accused of making, the donations you make to a legitimate scholarship fund — either one you create or an existing one — truly are tax deductible.

You also might find these items of interest:

• Don't miss your state's 529 plan tax break deadline
• 8 ways the new tax law does — and doesn't — affect paying school costs
• Make paying for college a family affair, with contributions from parents, kids and Uncle Sam

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Originally posted as blog item on March 13, 2019; that post updated Sept. 4, 2020

Keywords: 529 plans, American Opportunity Tax Credit, college, Coverdell accounts, debt, Felicity Huffman, graduate school, home equity, Lifetime Learning Tax Credit, Lori Loughlin, Operation Varsity Blues, paying for college, scholarship, student loans, tax, tax credit, tax deduction, taxes, university, workplace benefits