When you have a child or family member in college, tax season may actually mean a boon to your financial situation. One of the best ways to make college more affordable is to take advantage of federal tax breaks and programs designed to help families saving and paying for college.
Tax Breaks on College Savings
A good program for saving for college that comes complete with tax benefits is a 529 Plan. An education savings plan operated by a state or educational institution, this plan helps families set aside money specifically for future college tuition and costs. As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits.
With 529 plans, all earnings to the account are tax-deferred. Additionally, distributions taken out for use in college costs are tax-free. The only stipulation on this is distributions must be made before 2011.
Other savings plans are also rich in tax benefits:
Coverdell Education Savings Accounts. Earnings are tax-deferred and distributions are tax-free. This account also offers tax-free withdrawals for primary and secondary school expenses before 2011.
U.S. Savings Bonds. Bought a bond after 1989? If the purchaser was at least 24 years old, the EE and I bonds may be withdrawn tax-free when used for spouse or dependent’s college tuition and fees. This benefit is limited by income, and limits change every year.
Individual Retirement Accounts. If you contribute to an IRA for the express purpose of paying for college, you will be rewarded. Early withdrawal penalties are waived for both Roth and traditional IRAs for qualified college costs of yourself, your spouse, your children, or your grandchildren. However, taxes may still be due on withdrawals – check your specific IRA guidelines.
Tax Breaks on College Payments
Consider this: almost all scholarships and grants are tax-free if given without stipulations for services received. Putting effort into researching all scholarship and grant opportunities relevant to your situation will pay off in the long run.
What about loans and straight payments? Tax benefits exist and can significantly help parents, spouses and children. Each may be dependent on family income, amount of tuition and amoutn paid, as well as scholoarships or other allowances received, so always check the most recent guidelines provided by the IRS.
Tuition and Fees. Qualified taxpayers can take an income adjustment even if they do not take any deductions. Up to $4,000 may be deducted from tuition and fees required for enrollment or attendance at an eligible postsecondary institution. (Personal living and family expenses, including room and board, insurance, medical and transportation, are not qualifed.)
Deduction for Student-loan Interest—Up to $2,500 in student loan interest may be deducted as an income adjustment.
Hope Scholarship Credit. The Hope Scholarship is a tax credit subtracted directly from the tax a family owes, instead of being subtracted from taxable income like a tax deduction. For the 2006 tax year, families may claim a tax credit up to $1,650 for each eligible dependent for up to two tax years. The Hope credit is available only until each student's first two years of postsecondary education are complete. Taxpayers must apply for this credit with a special form found at the IRS website.
Lifetime Learning Credit. This is a tax credit subtracted from the taxes owed. Taxpayers may claim a tax credit of up to $2,000 per tax year. There is no requirement that the student be studying towards a degree or be enrolled at least half time, and there is no limit on the number of years the credit may be taken.
Families can usually qualify for either the Hope Credit or Lifetime Learning Credit, but not both. You can qualify for one of these credits and the tuition and fees deduction simultaneously.
For more complete details on qualifying for tax credits and deductions, as well as information on tax-deferred savings methods, visit the IRS website at www.irs.gov, and the National Association of Student Financial Aid Administrators site at www.nasfaa.org.
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